Euro update 2011

Interest rates

Euro interest rates are going up, while sterling and dollar interest rates are not. That distinction has set the tone for these three currencies over the last month.

Having promised in early March that it would act against an above-target rate of inflation – 2.7% at the last count compared to a target of 2% – the European Central Bank set the ball rolling in April by lifting its refinancing fate from 1% to 1.25%. Investors are in no doubt that further increases are in the pipeline.

Meanwhile, in London the Bank of England seems even less inclined to tighten monetary policy. At the beginning of the year investors pencilled in May 5 as the likely date for the bank rate to move North from the 0.5% position it has occupied since March 2009. That date has now been erased and replaced by November 10. Maybe. There are two reasons for the big change in sentiment. Firstly, UK inflation fell back in March from 4.4% to 4.0%. Secondly, the nine members of the monetary policy committee have fallen into a consistent pattern of voting six-three against a rate increase.

Across the Pond there is no suggestion whatsoever that higher US interest rates might be on the horizon. As in London, a vocal minority of the Federal Open Market Committee believes that perennially ultra-low rates simply store up trouble for the future, but the majority of voting members are fearful that to raise rates too quickly would prejudice America’s economic recovery.

The net result has been a race to the bottom between the pound and the dollar as the euro strode ahead. The dollar is winning the contest, thanks to Standard & Poor’s. The firm has attached a “negative” outlook to the United States’ AAA credit rating. An unexpected improvement in UK retail sales provided the pound with a surprise bounce just before Easter but nobody is under any illusions that it signified a turnaround in sterling’s fortunes.