The decision to reduce interest rates across countries joining the euro next month came as a surprise. For some months now it had appeared that Irish interest rates would have to fall to the base levels which have applied in Germany and France for months now. Yesterday, however, the euro zone central bankers announced that this base level of interest rates was to fall from 3.3 per cent to 3 per cent. In response, the Central Bank here announced a 0.69 percentage point fall in Irish rates, bringing our base wholesale money market interest rates to the 3 per cent level.
The European Central Bank may not be formally taking up the reins until January 1st next year. But yesterday's move shows that we are now effectively inside the euro-zone and that the new single currency bloc is now acting as one in setting monetary policy. Our partners in the centre of Europe now fear that the outlook for economic growth next year is worsening, as the EU suffers from the hangover of the Asian crisis and the recent international turmoil. Hence the decision to reduce interest rates in an attempt to support the level of economic activity. The central bankers insist that recent calls from the German and France governments for lower rates was not a factor in their decision.
Our economy, of course, is in a completely different position from most of the rest of Europe, experiencing record growth and falling unemployment. While the overall rate of inflation remains moderate, pressures have emerged in some areas of the economy, notably the housing market and parts of the jobs market. The day after a Budget which will inject hundreds of millions of pounds into the economy, a further reduction in interest rates is the last thing that the Central Bank will have wanted to sanction. Clearly, however, Irish concerns are far from paramount in setting interest rates in the euro-zone and we have no choice but to go along with the rest. Eurozone interest rates look set to stay at these low levels next year and could even edge down further.
What impact will it all have on the economy? The Government has forecast that growth will slow a little next year, a view shared by most forecasters as the economies of many of our major export markets show lacklustre growth at best. Against this background - and with the recovery in the value of the pound against sterling lessening the risk of rising overall inflation - the reduction in interest rates and the expansionary Budget do not look as dangerous a mixture as they might have earlier in the year.
However there are risks. In the housing market, in particular, lower interest rates will give a further boost and add to what is already a dangerous price spiral. The Government has already implemented some measures recommended by the Bacon report and as part of the Budget is spending more on local authority housing. But it must now urgently examine what more should be done, particularly what further measures would accelerate the availability of land for building and the rapid construction of houses.