Euro update 2011

UK interest rates

It was less of a downward drift for Sterling in March than an upward drift for the Euro but either could have been justified by the same logic: interest rates, as usual. More precisely, it was investors’ perception of which would go up first, the Bank of England’s Bank Rate (currently 0.5%) or the European Central Bank’s Refinancing Rate (1.0%). After a period during which the greatest hope was fixed on Sterling, anticipation has now swung firmly towards the Euro.

Three members of the Bank of England’s policy committee want to increase interest rates as a response to inflation, which has now hit 4.4%, well over twice the Bank’s 2% target. But the six other members, including the governor, still believe it would be pointless. They say inflation will return naturally when the VAT increase drops out of the equation next January and oil prices fail to repeat the one-third rise they experienced over the last 12 months. From what he said in his Budget speech the Chancellor appears to be sympathetic to that argument, so there is not even any political pressure for a rate increase.

In Europe, on the other hand, the European Central Bank looks determined to respond to the inflation threat, even though at 2.2% it is only half as threatening as in Britain. The ECB president has as good as promised that Euro interest rates will go up in April – and when he says something like that the market is bound to sit up and take notice.

Euroland clearly has economic problems of its own, the biggest being what to do about Portugal now the parliament there has thrown out a bill to balance the budget and manage the country’s debt. It has become inevitable that Portugal will follow Greece and Ireland into EU-administered receivership and Spain might not be far behind. But for now it is interest rates upon which investors focus and the Euro is out there in the lead.