Trichet Remains Cautious about Increasing Interest Rates

The European Central Bank has given rise to further speculation that it will decide against increasing the rate of interest next week. The bank has previously maintained a hard line on inflation, which has seen it increase interest rates eight times since December 2005.

There are a number of reasons why the European Central Bank would consider leaving interest rates at their current level. As yet, the full extent of the credit crunch is unknown. The increased complexity of financial markets during the past decade has meant that in the event of a crisis affecting global financial markets, it becomes difficult to identify all of the victims. It will be many months before the true degree of casualties is realised.

The ECB will be wary of introducing another interest rate increase so soon for a number of reasons. As a result of the current credit squeeze, there may be a significant decrease in the demand for money which would only be further aggravated by an increased interest rate. So far, this mostly concerns the financial sector. It is important that this damage is curbed and prevented from spreading to the economy at large.

However, there will not be any interest rate cuts by the ECB to mirror the cuts undertaken by the US Fed in recent weeks. Price pressures remain within the Eurozone and still threaten inflation. Escalating commodity prices worldwide are putting pressure on consumer prices. President of the European Central Bank, Jean Claude Trichet, has been adamant all along that combating inflation was to be one of the primary focuses of the ECB. This focus was maintained with “strong vigilance” and led to eight successive interest rate increases in an eighteen month period. Despite this, and given current circumstances, Trichet has yesterday distanced himself somewhat from his earlier stance. Speaking in Budapest, he stated that the ECB had “not pre-committed” to increasing rates on September 6th. This would imply that the ECB has decided to proceed cautiously and now places the achievement of stability in financial markets ahead of tackling inflation.

The current turmoil in global financial markets could see Eurozone interest rates lingering around the 4% mark for some time. This could be crucial to the achievement of stability in credit markets and to the revival of investor confidence at a broader level.

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