With European credit problems still largely unresolved, especially in England and Germany, the region’s largest central banks remain steadfast on interest rates. And that might be their Achilles heel this fall as credit markets continue to freeze despite multiple injections of bank credit in the open markets since August 9th.
Over the last seven weeks, the European Central Bank (ECB) has pumped the financial system with over $500 billion dollars (€352 billion euro) in an attempt to instill confidence – hoping cross-border banks can start lending to one another again. However valiant an effort this may be, it isn’t enough to placate fragile debt markets across Europe. What Europe needs now is lower interest rates.
Euro Libor rates, or euro inter-bank lending rates remain elevated and in excess of the European Central Bank’s base rate of 4%. This morning, the ECB 3-month benchmark Euro Libor rate sits at 4.79% -- way above the base rate. The Federal Reserve, which cut the Fed Funds rate last Tuesday, has successfully managed to reduce credit risk and has effectively opened the lending spigots, at least gradually. But the Europeans, including The Bank of England, are making a serious policy mistake by not reducing lending rates. As my colleague, Mike Burnick, pointed out this week, the credit crunch isn’t over.
Earlier this week, the Norwegian central bank raised lending rates as booming oil exports and a thriving consumer market continue to threaten economic overheating in Europe’s most prosperous economy this decade. The krone has been mighty strong over the last few years, rising another 5.8% in 2007 vis-à-vis the euro. Amid soaring oil prices and strong consumption, the Norwegians are right to boost lending rates, especially since they harbor no sub-prime exposure. But that’s not the case with the rest of Europe, which is slowing markedly this fall amid a credit squeeze and a soaring euro, stifling exports.
One of the biggest policy blunders now is occurring in the United Kingdom where The Bank of England (BOE) made a huge mistake not creating enough liquidity in overnight money-markets earlier in August, exacerbating the mortgage-backed crisis.
So far, the only casualty, Northern Rock, has been rescued by The Bank of England following a run on the mortgage lender earlier in September. But the damage has already been done as most British banks are still reluctant to lend in overnight markets, extending the credit crunch. The above 3-month sterling Libor chart depicts a big spike in rates over the last six weeks in England, the same phenomenon plaguing the ECB now and the Federal Reserve earlier this month. The message is clear: Injecting money-markets with periodic doses of liquidity isn’t enough; what the markets want is lower lending rates.
Overall, the Europeans continue to talk a tough game on inflation, reluctant to cut interest rates. But historically, all central banks walk the same line, and that means the ECB and the BOE will eventually join the Fed and cut rates this fall. This will also boost gold prices in 2008 as non-dollar fiat currencies are debased. The Europeans are getting killed on fresh dollar weakness as the buck hits a 15-year low against major world currencies; lower rates would offset the currency drag now pressuring exports.
In Europe, like the Fed, it’s Print or Die.
Have a good weekend.
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