The European Central Bank (ECB) may have decided to leave interest rates unchanged yesterday but it also signalled clearly that the cost of borrowing may have to rise shortly in order to dampen down inflationary pressures across the euro zone. Mr Wim Duisenberg, the ECB president, said that after a lengthy period in which Europe has enjoyed what he termed "a truly accommodating monetary policy stance.." , the bank was now looking to the future. "We have to adopt and have a monetary policy stance that will be conducive to sustained, non-inflationary growth", he said.
By leaving rates unchanged for now, the ECB is clearly anxious to avoid any action which might inhibit the continuing economic recovery across the euro zone and especially in Germany. The ECB has managed to support the recovery by maintaining the most benign monetary regime but, by signalling an interest rate rise, it is already looking beyond the recovery to a period of sustained growth among the 11 member States of the euro zone. The prospects appear bright. By most estimates, economic growth across the zone will run at about 2.75 per cent next year. It appears that, after years of sluggish growth, the euro zone economy is now poised to reap the benefits of positive fiscal and monetary policies, a recovery from the effects of the Asian crisis and expansionist government policies.
It is now expected that the ECB will increase interest rates by up to one percentage point over the next year as it moves to curb inflationary pressure. Given the collective memory in this State of the very high interest rate cycle in the early 1990s, speculation about any increase will unsettle many. But it is important not to overstate the scale or impact of the ECB action; the most likely scenario is that interest rates will rise from 2.5 to 3.25 or 3.5 per cent . In this State, borrowers will enjoy a further safety blanket; the new level of competition in the mortgage market means it will be quite some time before interest rates will return to the kind of levels evident before the arrival of Bank of Scotland - even if the ECB lifts rates over the next year.
From the perspective of this State, the recovery in the euro zone appears certain to trigger still further growth in output and exports. It may mean the current economic boom will be stronger and more sustained than commonly expected. In framing its Budget, the Government will be conscious of the need to satisfy wage expectations and to allow every sector of the economy share the fruits of the boom. But it must also be conscious of the warnings, most recently from the Central Bank, that the economy does not overheat. With the European recovery likely to further boost growth here - despite some edging up in interest rates - the Government must be careful not to inject too much money into an economy which is already enjoying robust good health.