Power & Market

Europe Isn't Budging on Its Rock-Bottom Interest Rates

Europe Isn't Budging on Its Rock-Bottom Interest Rates

This week, the US Federal Reserve raised the target for its key rate — the Federal Funds Rate — to 1.5 percent. That's the highest its been since 2008, although well below 5.25 percent rate reached during the last expansion. Europe, however, has signaled it has no plans to follow the US in moving key rates upward. 

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The Wall Street Journal reports today that European central banks "showed continued caution, leaving policy unchanged":

Despite that stronger outlook, Mr. Draghi once again had to acknowledge that the inflation outlook is “muted.” Indeed, the ECB’s economists don’t expect the inflation target of just below 2% being reached in either 2018 or 2019. This isn’t an ECB-specific problem, but it helps explain why interest rates are set to stay where they are “for an extended period.”

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The U.K.’s central bank raised it’s key interest rate for the first time in a decade last month, and Thursday confirmed it isn’t in any hurry to follow that up. Policy makers face a unique challenge in the U.K.’s departure from the European Union in 2019, and the path for rates is therefore more uncertain than elsewhere in Europe.

Draghi "repeatedly stressed that what the eurozone is experiencing is no longer a mere 'recovery' but instead an 'expansion...'" One is left wondering, however, why the ECB refuses to let up on the stimulus if the economy is doing so well. 

Over the past decade, central bankers have gotten into a fairly predictable habit of declaring the economy to be "strong" or "robust" while simultaneously refusing to scale back the central bank's stimulus. As numerous commentators have pointed of, though, Europe's monetary policy remains in the service of debt-laden governments which rely on rock-bottom rates to keep debt payments low. Moreover, the threat of a banking crisis in Italy isn't exactly exactly motivating central bankers to raise rates. 

From their perspective, it's better to just keep rates low indefinitely, and hope for the best. 

Not all central banks outside the US are as cautious as the Europeans. The Bank of Canada was raised rates twice in recent months, and is now hinting that it may raise rates again soon:

Financial markets expect the bank to raise rates further in 2018 after hiking in July and September, but analysts are divided over whether the next move will come as soon as Jan. 17.

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