No Rate Cut Says ECB as Markets Bet Fed Will Relent

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The European Central Bank has decided to maintain interest rates at the current level for the foreseeable future. ECB said:

“The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively.

The Governing Council now expects the key ECB interest rates to remain at their present levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.”

That’s right. European interest rates are at zero percent, although there’s little chance you’ll be given a loan at anywhere near 0%.

The reason interest rates are so low is because there’s still quite a bit of inflation in Europe, standing at 1.9%.

EU inflation rate, June 2019

There is some growth, but at 1.5%, barely keeping up with inflation. Meaning the problem may well be that people are not spending. More precisely, the government is not spending.

EU wide public debt is at about 85% of GDP. For USA, it’s at 105%. There’s some correlation, although not very perfect:

EU public debt, June 2019 EU growth, June 2019

The time-lines are a bit different and the debt levels may have partly fallen because, well, people are paying Germany to lend them money with German yields down to a record low of minus 0.2250%.

Plus, EU is quite diverse with some nationalism still as continent wide fiscal policy is not really yet a thing with EU actually spending more as percentage of GDP, about 45%, than USA’s 38%.

Both have been falling, however. America down from 43%, while EU down from 50%.

EU Spending, June 2018

This spending fall may in part explain the fall in debt levels for EU. While in America they have risen because tax cuts and because Fed has increased interest rates.

Markets are now betting Fed will lower interest rates from the current 2.5%, with CBS stating:

“Wall Street cheered a signal from Federal Reserve Chairman Jerome Powell that the central bank is open to cutting interest rates this year if trade conflicts with China and Mexico slow U.S. economic growth.”

A rate cut may be good for US, but not very good for Europe if Europe does nothing. That’s because it would effectively be a tax cut for indebted Americans and also a tax cut for US exporters as American goods would be cheaper.

On the other hand, Europe is being hit with a double whammy. Not only might US goods become cheaper, but European goods may become more expensive for Americans as a rate cut might weaken the dollar while strengthening the Euro.

Euro starts rising against the dollar, June 2019Euro starts rising against the dollar, June 2019

Conceptually a rate cut means US can more easily service its debt, so the dollar should be more in demand. On the other hand, borrowing would be cheaper so more dollars might be created temporarily.

Yet by the latter logic, borrowing in Europe is technically free, so the euro shouldn’t be so much stronger than the dollar.

It is because the government is just not spending enough. For example, EU is spending only 2% of their GDP on research, while for America it’s about 2.8%.

That doesn’t sound like a huge difference, but we’re speaking of trillions. US is spending about a third more on research than EU.

That might partly explain why the tech sector is a bit stronger in US, but the problem for EU is that there isn’t much coordination.

For the continent to become more democratic, it has to merge a bit more. Perhaps even have elections for a European president.

In addition, as the continent is using one money, this is in effect one economy. So they should perhaps coordinate spending a bit more. Especially when it comes to things that really matter, like research.

Otherwise if they’re going to keep interest rates at 0%, then perhaps they should have a way of forcing banks to pass that on to consumers because credit cards still charge at times as much as 20% and a mortgage is almost impossible to secure while business loans are almost non-existent unless in all these cases you are already relatively wealthy and don’t even need the money.


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