The European Central Bank last week announced that its bond buying programme would be cut back again in October, before being wound up completely at the end of the year. While not completely unexpected the announcement saw the euro slump. While this might be bad news for those travelling abroad in the coming weeks, what else will the end of quantitative easing mean for Irish consumers and businesses.
Davy's chief economist Conall MacCoille said it was extraordinary to see that on the day the ECB announced the end of quantitative easing, the interest rate on 10-year government bonds actually fell. Mr MacCoille said that while the end of QE had been well flagged, the big unexpected surprise for the markets was the ECB's signal that it would keep interest rates at their record lows until around September 2019. Last week, the US Federal Reserve also signalled that it expected US rates to go up to 3%, with two more rate hikes pencilled in for this year and two more next year.
"You are looking at a situation where investors are seeing interest rates of 3% in the US and 0% in Europe, so if they want to make any return on their money, the US is the place they will go," Mr MacCoille said. He said that is why the commitment by the ECB to keep rates on hold came as a big surprise and is the reason the euro saw the big drop in value against the dollar on Thursday.
The economist said that central banks can get their forecasts wrong, just like everyone else. He said that if the US economy is doing well and is generating inflation, it is hard to believe that this growth will not transfer across to Europe, which will help exports in Europe, and in turn boost euro zone inflation. ECB President Mario Draghi was also keep to stress that his commitment to low interest rates was data dependent and risks - including protectionism and a slowing euro zone economy - as well as higher than expected inflation could force him to break his promise. He also said there could be more than one rate rise before the end of 2019 if things go well for the euro zone economy.
Mr McCoille said the last time such a gap existed between interest rates in the US and Europe was in 2006-2007 when the US Federal Reserve was already cutting US rates. He said there was a view at that time that the UK and Europe economies were fine, but there are more trade and financial linkages between the US and Europe than in previous decades and so if the US is doing well because of those linkages this can result in higher inflation and growth in Europe. The idea that we can have this big gap in US and European interest rates is something that is likely to change in the coming years, the economist added.
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