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European Banks Enjoy Loose Monetary Policy, Consumers Less So

As expected both the European Central Bank and the Bank of England have left base rates unchanged at 1.0% and 0.5% respectively.


The no-change decision in both cases was inevitable. Europe is slowly emerging from the worst recession in 70 years but the momentum of the recovery is not creating serious inflationary pressures and unemployment continues to worsen. The central banks, true to form, are creating a recovery that favours corporations and commercial banks in particular over the man-in-the-street.


In the UK the BoE also confirmed it would keep its £175bn quantitative easing program in place further helping banks and financial institutions with their liquidity requirements.


With UK rates at an historical low it is useful to compare the 0.5% base rate to the real cost of borrowing for home buyers. A quick review of the most competitive deals provides borrowers with mortgage rates between 2.9% APR and 5.2% APR at a loan-to-value of 60% to 75%. Interest rates available to home-buyers with a smaller deposit are much higher. The best first time buyer rate appeared to be 4.6% APR.


Even taking into consideration the fact that rates will rise of the next 2 years its clear the banks are using the low base rate primarily as an opportunity to rebuild their balance sheets and secure healthy margins, at the consumers expense. Interestingly, Lloyds Group and Royal Bank of Scotland, despite the UK government’s significant equity interest were absent from the best buy list. (Sources: Moneysupermarket and John Charcol Mortgages, 9th October 2009).


The UK base rate is predicted to stay at 0.5% into 2010. The future pace of rate increases is still unknown and will be a function of the strength of the recovery, and associated inflationary pressures, through Q4 2009 and Q1 2010.


The ECB is likely to commence monetary tightening prior to the BoE, as the Euro-zone’s major economies Germany and France exited recession prior to the UK.


The ECB rate decision was accompanied by a statement the contents of which explained in great depth the thought process of the committee and the following extract perfectly articulates their stance of cautious optimism:


“On the basis of its regular economic and monetary analyses, the Governing Council decided to leave the key ECB interest rates unchanged. The current rates remain appropriate. The incoming information and analyses since our last meeting in early September have confirmed our previous assessment. While annual HICP inflation was still slightly negative in September, according to Eurostat’s flash estimate, it is expected to turn positive again in the coming months and to remain at moderately positive rates over the policy-relevant horizon. At the same time, the latest information further supports our view that the euro area economy is stabilising and is expected to recover at a gradual pace.”

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