Why raise Eurozone rates now?
9 Nov 07

Eurozone inflation sits stubbornly at 2.6%, well above its target of “close to but less than 2%. Interest rates currently stand at 4%, and Wolfgang Munchau of the FT argues that the ECB should raise rates, but thinks that it will not happen.

The case for raising rates seems strong:

• Inflation looks to stay quite high amid high food and oil prices
• Tightening labour market and wage pressures e.g. 4% wage deal in Austrian engineering industry
• Tight monetary and credit conditions
• Economic growth at or above potential – 2.5% for 2007 and 2.1% for 2008

The case against raising rates:

• Uncertainty caused by credit market turmoil BUT ECB paid to make decisions in uncertain times!
• Rise in money market rates may mean that rate rise by central bank not needed BUT ECB serves a signalling function which it would lose if it led markets dictate.
• Rise of the euro against the dollar BUT the exchange rate that matters is the real effective exchange rate which has not seen dramatic movements

Therefore, I think the ECB should raise rates, but also think that it will not happen. Unfortunately, political influence will get in the way.

Links:
Raise Eurozone rates now or risk inflation – The FT, Wolfgang Munchau (4 Nov 07)