Interest rates are back in the spotlight…well, maybe not back in the spotlight as there is always a focus on rates, but I have been seeing financial headlines about rate rises, timings and whether UK base rates will be on the up prior to the next election.
The increasing strength of the property market (despite the latest monthly figures that showed a negative figure), increasing employment and general confidence in the economy are all pointing towards an increase sooner than previously predicted.
In contrast on the continent we have the ECB under increasing pressure from the IMF and other institutions to bring in their own version of QE and to cut rates. The backdrop to this is fears of deflation within the Eurozone and all the issues that result from that.
The ECB held rates at 0.25 per cent, but many commentators and market analysts are calling for 0 per cent rates as well as the QE. The reasons for this are that inflation is at 0.5 per cent, below the 1 per cent danger threshold of the bank, and deflation is looming large.
This is going to increase the North versus South battle in Europe. The weaker States, and those with large burdens of government debt, are looking for an inflation and QE-backed escape route out their debt trap, but this has been an on-going conflict with the Bundesbank and other northern Europe hawks, who up to this point have been winning the argument over effectively bailing out countries that have overspent, but even their resistance is crumbling.
In a double whammy for the struggling economies of the Eurozone the Euro is up 6 per cent on a trade weighted basis over the last 12 months and is around 1.37 against the US dollar.
This means that 1.40 is approaching and there are fears that this could drag the whole of Europe back towards recession as exports become less competitive.
It seems counter-intuitive that the Euro would be strengthening with the backdrop of economic weakness, but one of the reasons behind this strong currency is that European banks had repatriated around $1 trillion over the last five years (source Morgan Stanley/The Telegraph) in an effort to shore up their balance sheets under the new banking rules.
There has also been the fact that countries like the UK and the US have been happy to see their currencies weaken as one method of stimulating the economy (and especially the export sector), while the aforementioned hawks in the Eurozone have been holding firm to their principles.
In amongst all this the smaller countries have been having their own problems with QE and ‘hot money’ looking for returns causing exchange rates to fluctuate and to affect the real economy. As an example, Switzerland introduced negative rates and Denmark also has negative base rates to deter capital inflows and an over-priced currency.
So, things may not be quite so clear cut for the UK as Europe is still our main trading partner and events there may yet have an effect on both our interest rates and exchange rate.