Rate increase an unwelcome added risk - The Irish Times

ANALYSIS: More expensive money from the ECB will suck even more cash from a struggling Irish economy, writes ARTHUR BEESLEY 

EUROPEAN CENTRAL Bank (ECB) chief Jean-Claude Trichet often tells euro zone stragglers they need to keep ahead of the curve to keep the markets at bay. His abrupt signal of an interest rate hike in five weeks smacks of determination to take his own advice.

From an Irish perspective, this is bad news indeed. For homeowners with tracker and variable-rate mortgages, the looming increase will further add to the strain of recession.

Although warnings from Fine Gael and Labour about the State’s parlous finances are predictably ominous, the imminent ECB manoeuvre will suck yet more money from a cash-starved economy. With the banks still on life support and hard-pressed borrowers struggling to make ends meet, higher interest rates add fresh risk into the equation.

There is more. Taoiseach-in- waiting Enda Kenny is embarking on a difficult drive to extract better bailout terms for Ireland. A rate rise from Frankfurt could however dilute or eliminate the benefit from any lowering of the interest Dublin pays for rescue loans. This is determined by a fixed surcharge which is added to the borrowing costs of Ireland’s euro zone partners and the European Commission. Their borrowing costs will rise as the ECB pulls the interest lever.

Kenny already has a job on his hands to secure even a modest cut in the surcharge. Even if he does so, the net effect may be negligible, so recovery from an appalling implosion becomes even more difficult.

Although Trichet made a point of saying he was not about to embark on a series of rate increases, analysts are already predicting a further rise in the second half of the year. Not so long ago, some economists were predicting that the core ECB rate would remain at a record 1 per cent low into 2012.

That’s all changed. Notably absent when Trichet addressed reporters yesterday was the argument that present interest rates are appropriate. The bank believes they are not.

Notable too was his signal that the bank’s policymakers were exercising “strong vigilance” against inflation. To that implicit signal that a rate rise was on the way, Trichet added more certainty than usual by explicitly warning of an increase next month.

This assertiveness, which stunned markets and caught analysts off guard, suggests he did not want to leave any doubt about ECB plans. If he had not been so direct, the impression might have been formed that the next rate rise might come later.

Barring an unforeseen inflation dip – very unlikely, it must be said – rates will go up 0.25 per cent in April.

The reason for all this is clear: pressure on the price of oil thanks to a wave of turmoil in north Africa and the Middle East. Up 15 per cent since mid-February alone, oil traded this week at its highest level since August 2008, immediately before the Lehman collapse. Whereas the average price of a barrel was about $80 last year, it closed above $114 last night. This rattles the ECB, whose prime task is to keep inflation below but close to 2 per cent.

While the bank’s staff forecasters are already predicting that inflation will settle between 2 per cent and 2.6 per cent this year, Trichet stressed that such figures took no account of the oil increase since mid-February.

Such volatility could be with us for some time to come. There is no sign of any resolution to Libya’s troubles nor any sign of an easing of the tensions in the wider Arab world.

The ECB’s big fear is rising oil and food prices leading to wage demands, thus magnifying inflation. All of this has potential to waylay the still-fragile recovery of the euro zone, something which explains the speed at which the ECB is now moving.

Europe’s key aim right now is to consolidate the nascent German- led rebound. Anxiety about disruption in Ireland, Greece and other weaklings is but a sideshow. Similarly, it matters little that the looming increase will turn heat again on Portugal as it strives in the face of crippling borrowing costs to avoid a bailout.

No one wants to go down that road, but Trichet argues that the wider euro zone interest demands a rate hike. In these matters, he’s the boss.

via irishtimes.com

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