Eurozone Interest Rates: Heading To 1.00%
I am of the belief that the European Central Bank (ECB) will cut its key interest rate to 1.00% by the end of 2009 from 2.00% at present.
The economic outlook for the eurozone is bleak to say the least, with Business Monitor International forecasting a 3.0% contraction in GDP in 2009. Meanwhile, inflation is in ultra-low territory. I reckon these factors will force the ECB’s hand. Consider also the following:
• The consumer: In January, the European Commission’s Consumer Confidence Indicator plunged to a record low (since January 1985 in fact) of –33. This reflects the bursting of the asset price bubble, tighter consumer credit conditions, and rising unemployment.
• The manufacturing sector: This is in dire shape. The Commission’s Manufacturing Confidence indicator fell to a record low of –36 in February.
• The banking sector: I am worried about European banks, especially as the recession will undermine loan quality even further. What scares me is that eurozone banks have lent very heavily to emerging markets – and emerging Europe in particular. In Austria’s case, the amount of loans to emerging Europe, at US$277bn, is equivalent to 76% of the country’s GDP. With emerging European currencies collapsing in value, the inability to repay loans could be the transmission mechanism for the crisis to move from eastern to western Europe. This in turn would necessitate massive liquidity injections by the ECB.
Overall, I should point out that while every other major world currency is backed by a strong central government, this is not the case with the euro. There is no single political or fiscal eurozone authority, and thus no-one to implement fiscal transfers from the richer states to the poorer ones. This means that there will be greater pressure for the ECB to cut rates to tackle problems which are not dealt with adequately at the political level.