The Hindu Business Line : Continental strike against inflation

The latest decision by the Bank of England and the European Central Bank to increase interest rates by a quarter percentage point to 4.75 per cent and 3 per cent respectively has surprised the financial markets, with blue-chip stock and bond prices edging lower. The central banks' move is widely interpreted as an unexpected pre-emptive strike against inflation. Analysts expected the decision to increase the benchmark rates to come in November. However, according to sources, "something in the quarterly report" (as yet confidential) aroused a sense of urgency in the Monetary Policy Committee at the ECB headquarters in Frankfurt.

The ECB has raised interest rates to bring the current 2.5 per cent inflation rate down to 2 per cent in the medium term against the "background of firm economic growth of broad money and credit". European industry has argued that the current boost in interest rates may stifle economic growth in key EU economies.

But the ECB chief, Mr Jean-Claude Trichet, warned that more rate hikes could follow, as he spoke soberly about the perceived ravages of rising inflation, coupled with the prospects of lacklustre economic growth (less than two per cent) and high unemployment, now hovering above the double-digit mark in major EU economies.

Room for optimism

Some 20 million EU workers ( about 10 per cent of the workforce) are unemployed and live off welfare payments. Yet, this is not rated a "scary scenario," for the unemployment level has remained `static' despite the recent influx of nearly half a million migrant workers from former communist-ruled East and Central European region.

Indeed the $11-trillion-plus Euro Zone offers some optimism. According to the latest data, unemployment in the Euro Zone fell to a record low 7.8 per cent in June and there has been an improvement in retail sales. But the European establishment and the people still worry about the so-called `unknown' factor. Anxiety continues about the unpredictable political and logistical development in the oil-rich West Asian region. This could dramatically affect the supply and price of oil — a major "imponderable factor" on the European economic horizon.

By increasing interest rates — to 3 per cent but short of the UK's 4.75 per cent and the US' 5.25 per cent — the Euro Zone central bankers are going the global way. For, in the emerging markets of China, India and Brazil too, the rates have been raised progressively. In the second quarter of this year, the IMF forecast that the world economic output would grow 5 per cent despite the high oil and energy costs. The question is if the growth rate can be sustained.

A further modest rise in interest rates to contain inflationary pressure is also conceivable, even if economic growth continues. The latest interest rate hike has slightly bolstered the euro and the pound sterling.

The silver lining

But a silver lining is that the inflation rate in the 12 European Union members that use the euro as trading currency, has remained constant at 2.5 per cent for the past three months. Analysts point out that this steady, but low, inflation rate "cannot be spiked" by higher wage demands by trade unions because they are left with no economic leverage. According to the ebullient German Economic Minister, Mr Michael Glos, the rate rise would not jeopardise the `upward' economic trend. This sentiment has been echoed in other key European financial capitals as well.

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