Squeeze that will help us, but not Europe
Sunday 12 October 1997
And, as this column suggested last month, that Europe-wide interest rate is going to be higher than some countries, including Germany and France, currently enjoy. This will squeeze monetary conditions at a time when European economic growth is still struggling to get out of first gear, and probably ensure that economic and monetary union do little to salve the crippling unemployment levels seen across the continent.
The Bank of England found itself in the unusual position last week of being one of the few European central banks to post a "no change" notice on its interest rates, as Germany's Bundesbank led a round of surprise interest-rate increases across Europe.
The rise in the German repurchase rate to 3.3 per cent from 3 per cent - the first rate increase in that country for five years, and the first time its rates have moved at all for more than a year - came sooner than many investors expected and sparked parallel moves in France, Austria, Belgium, Denmark and the Netherlands.
The French central bank described the moves as "part of a movement of measured increases of intervention rates by several central banks belonging to the core group of the European exchange rate mechanism". In other words, the key EMU players are already working together to set monetary policy for the European region as a whole, rather than defining interest rates that suit the needs of their domestic economies.
Neither Germany nor France need higher rates. More to the point, nor do their legions of unemployed workers. The French jobless rolls increased by 19,600 in August. Its jobless rate has been stuck at 12.5 per cent for 11 of the past 12 months. Annual inflation, however, is just 1.5 per cent.
In Germany almost 4.5 million people are out of work, a post-war record that has saddled the economy with an unemployment rate of 11.7 per cent. Unemployment in the UK, in contrast, is currently 5.3 per cent. Britain hasn't had double-digit unemployment since November 1993, and has seen the rate either fall or stay flat every month since January 1994.
The Bundesbank, however, has its collective mind on weightier matters than the German economy. "This was a tightening of interest rates for European purposes, and not for the German economic situation," said Nick Parsons, the currency strategist at Paribas Capital Markets. "It's a watershed in European relations."
As this column said in September, if the euro is introduced as planned in 1999, countries adopting the single currency will have the same official interest rate, set by the European Central Bank. Somehow, the gaps between existing central bank rates of 5.25 per cent in Spain, and 6.25 per cent in Italy, have to be dissolved.
The one-month rate for the present European currency unit is about 4.3 per cent. That indicates that central bank rates in the core European countries look set to rise by about a further percentage point. "Economic fundamentals are irrelevant to the rate debate," said Sonja Gibbs, an economist at Nomura International. "Rates are going up - and fast."
Traders and analysts had already been on interest-rate alert after the Federal Reserve chairman Alan Greenspan said that job growth in the United States has not slowed enough to prevent inflation accelerating. He also said that the world's largest economy was on an "unsustainable track".
Mr Greenspan's warnings revived concern that the Fed may raise interest rates by the end of the year. Europe's central banks, however, are mostly concerned with where monetary policy in Europe needs to be to ensure that the introduction of the euro goes ahead smoothly in 1999. While Mr Greenspan's comments may have hastened the Bundesbank's decision to move on rates, they probably didn't prompt it.
Last week's European interest rate increases have broken the general decline in borrowing costs prompted by the collapse in 1992 of central bank efforts to keep currencies in the European exchange rate mechanism locked within a tight range.
The shift to higher borrowing costs for European companies, apart from hobbling their investment plans, could also crush them on the currency side. Traders suspect that European central banks were intervening in the currency markets on Friday, trying to stem the fall in the US dollar prompted by the German rate increase.
Officials at the central banks of Germany, Belgium, Italy and Austria all declined to comment on this, although with higher exports looking like the only potential engine for European growth, it would make sense for them to try to prevent a weaker dollar making European exports more expensive, eroding the value of earnings European companies make from sales in the US.
While European Commission forecasts show that the total economy of the 15-nation European Union is likely to expand by 2.4 per cent this year and by 2.8 per cent next year, unemployment in the group's largest economies refuses to budge from double-digit levels.
Last week's rate increases show that the EU's 18 million unemployed will take a back seat to the campaign to put the future single currency on the same solid foundations that turned the deutschmark into Europe's most reliable money in the decades after the Second World War.
All of which could be good news for the UK. Many economists here expect the Bank of England to tighten policy just one more time, pushing base rates up by a quarter point to 7.25 per cent. As Europe sets off on the road to ever-higher interest rates, the UK government is likely to find itself rewarded with further cuts in its borrowing costs as investors pile out of European bonds and into gilts. The gilt market may find itself even more of a safe haven from EMU in the months ahead.
q Additional reporting by James G Neuger and Perri McKinney
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