European Central Bank Member Axel Weber Shows Europeans Divided Between Raising and Lowering Rates

Think it's just the Fed that is having trouble reconciling rising inflation and a weak economy? Europe is having the same debate with some believing rates should rise and others feeling it should fall. The outcome is important to the US since European rates impact the Euro/Dollar exchange rate.

Across the Atlantic, Europeans are facing many of the same economic issues we are experiencing in the United States - slowing economies and rising inflation.  This has made the job of the European Central Bank challening.  Should they cut rates to spur a weakening economy, or raise them to contain any inflation pressures?  The answer will impact the strength of the Euro versus the dollar.

Economist Nouriel Roubini's consulting firm sent out an email update today with this lead-in:

"We recently surveyed the economies at risk of recession and concluded that a full-fledged G7 recession is in the making, quenching hopes of economic and financial decoupling and bringing back those risks of global recession that we overviewed at the beginning of the year.  Moreover, one year later the credit crunch, inside and outside the U.S., is still alive and well."

That's hardly encouraging news.  Europe's economy shrank in the second quarter, and may do so again in the third, marking the first recession since the Euro was introduced in 1999.

But some, like European Central Bank Member Axel Weber believe that inflation is the bigger threat and that the bank must think about raising rates soon.  He is quoted in Bloomberg as saying:

``Monetary policy at the moment is roughly where it should be and I think the discussion about declining rates in Europe is premature,'' Weber, 51, said in an interview in his office in Frankfurt yesterday. ``If the economic outlook brightens somewhat again towards the end of the year and next year, which I still expect, we'll have to see if action is necessary.'

Inflation in Europe is running at 4%, significantly above the continent's target rate of 2%. 

Weber's comments assume that the European economy will recover sufficiently over the next six to nine months.  While that may happen, just the opposite seems to be occurring now as weakness spreads from the United States to across the world.

So what does this all mean?  I'd expect that Europe, like the United States will keep rates steady for the next three to six months.  If anything, I expect economic performance to deteriorate further as housing prices continue to fall in the US and Europe, the impact from higher energy prices settle in, financial institutions cut back on lending, and consumers take a glummer picture of their own finances.

As a result, until either the US or Europe show some significant growth, expect to see the dollar Euro maintain the current trading range.

 

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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Comments

  • JRodgers

    August 28, 2008

    I disagree. I expect the Euro to weaken versus the dollar as a result of the uncertainty that you cite here and the very fact that there is a fundamental shift in the currency cycle now.

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