Trichet may burden ailing nations with interest-rate rise
Jean-Claude Trichet’s shot against inflation may end up inflicting collateral damage on Europe’s most cash-strapped economies.
Primed to raise its benchmark interest rate this week for the first time in almost three years, President Trichet’s European Central Bank again faces the conundrum that its monetary policy rarely suits all 17 members of the euro area, where the kaleidoscope of growth ranges from record expansion to recession paired with a sovereign-debt crisis.
The upshot may be that the normalisation of rates from a record low of 1 per cent will disproportionately hurt Spain, Greece, Portugal and Ireland, while failing to nip inflation threats in Germany. Such uneven fallout risks exacerbating the two-speed European recovery and dealing further damage to the bonds of so-called peripheral nations. Credit Suisse Group AG is warning investors away from the region’s stocks and banks partly because of concern the ECB is making a policy mistake.
“As the ECB continues to tighten, it increases the risk that the sovereign-debt crisis comes back,” said Gavyn Davies, chairman of London-based hedge fund Fulcrum Asset Management LLP, which oversees about $1.5 billion in assets. “It will manifest itself with the troubled economies moving into slower growth rates, and the fiscal arithmetic will worsen again.” Trichet and his 22 fellow policy makers convene in Frankfurt April 7, a month since he surprised investors by signaling an increase in the ECB’s key rate by a quarter of a percentage point as inflation accelerated to 2.6 per cent in March, the fastest in more than two years. The yield on German 10-year government bonds, the European benchmark, rose for an eighth day, approaching the highest level in almost 15 months.
Primary goal
In enacting the first rise since July 2008, policy makers would be focusing on their primary goal of price stability rather than secondary mandates to support growth. They would also be taking the lead over the Federal Reserve in starting to withdraw emergency lending rates. Belgian Guy Quaden, who retired March 31 as one of the longest-serving ECB council members, said “a cautious increase” won’t hurt the region’s economic recovery because “both growth and inflation have become again significantly positive.”
Even so, the weakness of the periphery and its banks mean “the ECB simply cannot raise rates too aggressively without breaking up the euro zone,” said Simon Maughan, co-head of European equities at MF Global in London. A Bloomberg News survey predicts the central bank will lift its main rate to 1.75 per cent by year-end, based on the median estimate of 31 economists.