Sunday, March 27, 2011

ECB Interest Rate Hike May Affect Non-Euro Eastern European Economies

WSJ: ECB Rate Increase May Force Emerging Europe Into Hasty Tightening
Bloomberg: East European Central Banks May Ignore ECB Signal to Raise Interest Rates
AFP: Eurozone Private Sector Lending Stronger in February
Reuters: ECB Talks Rate Hikes, Braces as Portugal Crisis Deepens
Reuters: ECB's Bini Smaghi: Low ECB Rate Risks Distortions

In April, the European Central Bank (“ECB”) plans to raise its interest rate, which has been at 1% for almost two years. The ECB’s decision to raise the rate to 1.25% comes after concerns about inflation of the Euro, as well as worries that retaining low interest rates could induce some of the same problems that led to the recent global financial crisis. ECB executive board member Lorenzo Bini Smaghi explained that, “keeping rates so low makes monetary policy very expansionary and risks creating market distortions and encouraging excessive risk-taking by financial institutions.”

Inflation has been tough to battle for European nations because of rising oil and food prices due to turmoil in the Middle East and Japan. The ECB’s inflation rate is currently 2.4%, while its target rate is under 2%. A low and steady inflation rate is optimal. When the actual inflation rate is higher than the target rate, the central bank may raise interest rates in order to calm inflation. The interest rate hike will probably affect non-Euro Eastern European nations, whose small economies are vulnerable to changes in exchange rates. If these nations do not also increase their own interest rates, the differential could cause the Euro to rise against their currencies. This could then lead to higher import prices and inflation.

As of yet, Eastern European central banks have not signaled that they will raise interest rates along with the ECB. The Czech Republic has had an inflation rate under 2% and may not want to raise interest rates until later in the year. Czech rate setter Pavel Rezabek reported that the connection between ECB interest rates and Czech monetary policy “is not that automatic.” Bloomberg forecasters believe that Hungary, Romania, Poland and Russia will also temporarily retain their current rates. These small emerging economies are balancing their fear of inflation with the need to continue to stimulate growth with low rates and will all likely choose to delay a rate hike to promote continued growth.


Intrinsic said...

I think the ECB will raise the rate once, however it is diffcult to argue that a series of rate hikes will follow given the current market environment.

K. Anderson said...

Thanks for the comment. I agree that there are no signs that the ECB itself plans a series of rate hikes. The ECB hike will probably spur similar interest rate changes in non-Euro neighboring nations but perhaps not immediately. Due to the current market environment there is certainly a lot of hesitancy in raising rates.