Mark Lamb | Wednesday, 03 September 2008

Storm in a teacup

Weekly international investment round up to 3rd September 2008

The European Central Bank (ECB) decides tomorrow upon the direction of interest rates for the eurozone. The fact that the ECB’s Governing Council which includes 15 national bank governors does not actually take a vote on this important issue at their regular meetings may come as a surprise to many. Cynics may describe this as typical ‘centralised European non-accountability’ as the decision to increase, decrease or simply leave rates the same is reached by forming a ‘consensus of opinion’.
Commenting on this very matter in a recent paper Willem Buiter, the Professor of European Political Economy of the London School of Economics and Political Science, said that “since they don’t vote they can not of course publish either the aggregate vote or the individual votes.” He goes on to say that “the mystical process through which this consensus is achieved can only be guessed at.”
However the decision is reached it has widespread repercussions for everyone living in the eurozone and for those that invest within it. Homeowners and businesses hope for lower rates while by contrast savers pray for higher returns on their cash accounts!
Despite some desperate calls for a rate reduction in order to re-stimulate the region’s investment markets, house prices and economic growth it is widely expected that the ECB will leave the eurozone interest rate unchanged in order to combat their biggest fear, inflation.
Another fact which tips the scales in favour of leaving interest rates unchanged is based upon the ECB’s decision to raise interest rates back in July. For if they were to cut interest rates only two months later this would surely raise more questions on how such a decision was made and would probably also call into question the actual credibility of the bank.
A pressing problem for ECB President Jean-Claude Trichet remains the growing demand in Europe for higher wages to counter rising food and energy costs as demonstrated by Germany’s biggest Union IG Metall which has over 3 million members and are now preparing a demand for an inflation busting 6.5 per cent pay increase. Mr Trichet is fully aware that if wage growth accelerates core inflation is likely to rise as a result. Secondly, imported manufactured goods may become more expensive, reflecting the increased cost of their inputs. So far, intense competition in manufacturing in China etc. has helped keep costs down for the end consumer and the recent fall in oil prices have relieved some of the pressure but inflation in the eurozone still remains way above their 2 per cent per annum target.
So, while Mr Trichet sits with his colleagues in Frankfurt’s Eurotower swirling the end of their drinks as they contemplate the future, the outside economic turbulence is likely only to be seen as a short-term ‘storm in a tea cup’ and a distraction away from fighting their real fear which is the threat of uncontrollable inflation. The ECB is therefore unlikely to consider cutting rates until at least the end of the year in the hope that just like Hurricane Gustav the current economic storm will just slowly subside away.