Eurozone will need to handle rate hikes with extreme care

Caution critical, more so if it sets off a firming up of euro and impacts on trade prospects

For all the European Central Bank’s signalling of an interest rate “lift-off” next year, it might not get very far off the ground.

Some investors suspect even modestly higher borrowing costs will unleash a rally in the euro that undermines economic growth and curbs inflation. That could leave the currency bloc trapped with near-zero rates for years to come.

Spillovers from a potential slowdown in the US, the world’s largest economy, may also weigh on the ECB’s scope to tighten policy.

The dilemma for central bankers is that the Eurozone’s focus on exports and retrenchment in spending since the double-dip recession means that the bloc is now running a large current-account surplus. That puts upward pressure on the exchange rate, so far countered by the ECB’s ultraloose monetary stance.

“It highlights that the ECB’s job is impossible,” said James Athey, a money manager at Aberdeen Standard Investments, who says the institution may not even be able to raise the deposit rate above China will maintain a neutral and stable monetary policy while also assuring reasonable and ample liquidity, the People’s Bank of China has said.

The bank said it aims for balance among interest rates, exchange rates and international payments to ensure the stable and healthy development of the economy and to stabilise market expectations. The bank reaffirmed more financial support to the real economy and private sector.

China’s central bank didn’t follow the Federal Reserve’s interestrate increase last week, with analysts saying growing uncertainty would keep it from increasing borrowing costs for some time.

Leading indicators for China’s economy show growth continued slowing in September amid the escalating trade war with the US. zero, from minus 0.4 per cent currently. “It’s going to be difficult to carefully tighten financial conditions without an accident.”

Back in 2014, when the single currency was flirting with $1.40 (Dh5.96), the ECB cut the deposit rate below zero and laid the ground for an assetpurchase programme that will reach €2.6 trillion (Dh11 trillion) by December. The euro almost plunged to parity with the dollar before slowly picking up as the economy recovered. It’s now around $1.16.

Boost

That currency slide helped boost the current-account surplus by making Eurozone exports more competitive.

The monthly surplus is now typically well above €20 billion, compared with a persistent deficit in the run-up to the global financial crisis. The asset-purchase programme will be capped at the end of December, and ECB officials have signalled their comfort with market expectations for an interest-rate increase around the final quarter of 2019. Executive Board members Peter Praet and Benoit Coeure have both said there will soon be a need to provide guidance on what happens after lift-off.

“The region is obviously sensitive to exports, so if then the exchange rate strengthens too much, it will disrupt trade,” said Richard Ford, head of European fixed income at Morgan Stanley Investment Management. “If your base case is that the euro is going to rally above $1.25, then Europe may have some challenges.”