The latest interest rate cut by the European Central Bank (ECB) is necessary and overdue –although wholly unanticipated by financial markets. Homeowners on tracker mortgages, who account for some 59 per cent of all mortgage holders are obvious beneficiaries, although those with variable- rate loans are unlikely to benefit from the rate cut. A weaker euro, however, should boost economic growth, make Irish exporters more competitive, and enable them to sell more goods and services to non-euro area markets – the UK and US. Lower interest rates should also depress future sovereign borrowing costs in 2014, hopefully after Ireland has exited the bailout programme and returns to capital markets to finance its borrowing needs.
Given the weak state of the euro zone economy, the low rate of inflation (0.7 per cent) and the high rate of unemployment (12.2 per cent), an interest rate cut was inevitable. The parlous state of the euro zone was further reflected in last week’s credit rating downgrade of France. Quite clearly, deflation rather than inflation was the greater threat facing the euro zone, and the ECB acted to pre-empt that.
Nevertheless the ECB’s decision was a surprise. The move caught financial markets, which had anticipated a rate cut next month rather than last week, off-guard. Increasingly, the world’s major central banks have sought to give forward guidance on the future direction of monetary policy – to provide financial markets with more certainty. But their efforts have met with limited success. The Federal Reserve, the US central bank, was expected to start tapering last September, by slowly reducing its economic stimulus programme – its monthly purchases of government bonds. But the Fed, concerned about the pace and strength of the US recovery, failed to do so. Now, the ECB has also surprised markets by cutting interest rates sooner than it had signalled. Forward guidance has become a misleading indicator, increasingly adding to market uncertainty rather than reducing it.