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Tuesday 21 August 2018

Dan White: Will bankers risk eurozone by pushing up interest rate?

Speaking after this week's meeting of its governing council, ECB president Jean-Claude Trichet unveiled a new year shocker when he revealed that eurozone interest rates were likely to rise this year. Apparently the ECB is worried about inflation.

This is despite the fact that most eurozone economies are still mired in deep recession and deflation is a much greater risk than inflation. Unfortunately, we should not be surprised at the ECB's inflation fixation.

This, after all, is the same ECB that insisted on increasing interest rates in July 2008. The excuse then, as now, was inflation fears when the ECB mistook a short-term commodity price surge, particularly in the price of oil, for something more deep-seated.

That very same month the oil price bubble burst and two months later US investment bank Lehman Brothers went bust, triggering a second and far more serious phase of the global economic downturn. Within a few months the ECB was forced into a humiliating U-turn as it cut interest rates once again.

What are the chances that the EU, which is still obsessed with non-existent inflationary risks, will make the same mistake again? Very high, unfortunately.

The ECB's determination to apparently raise interest rates in spite of the severe economic recession gripping most of the eurozone, illustrates the two main problems afflicting the single currency project.

The eurozone is a two-speed economy. At its core Germany, whose economy has benefited massively from the fact that eurozone membership has prevented its currency from rising in value and thus massively boosted its exports, is growing like the clappers and needs an interest rate increase.

However, the peripheral eurozone economies, including Ireland, are being crucified by both their loss of competitiveness against Germany and their huge debt burdens. Ourselves, the Spaniards, the Italians, the Greeks and Portuguese need an interest rate increase about as much as we need a hole in the head.

If the eurozone were a democracy then Germany's need for an interest rate increase would have to be put on hold.

Unfortunately, the eurozone isn't a democracy. Ever since the single currency project was launched at the beginning of 1999 one member, Germany, has consistently been more equal than all of the others.

We first saw this after the turn of the century when the ECB deliberately kept interest rates low in order to foster economic recovery in Germany.

Something similar happened in July 2008 when the ECB bowed to demands from German inflation hawks for an interest rate increase, with disastrous consequences for the rest of the eurozone.

Now the ECB looks like making it third time unlucky when it comes to interest rates. It will most likely push up eurozone interest rates, probably in September.

This will have devastating consequences for the debt-ridden Irish, Spanish, Portuguese and Greek economies. For many Irish families, an interest rate increase will be the straw that breaks the camel's back.

It would also tear the eurozone apart. Truly, those whom the gods wish to destroy they first make mad!

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