ECB Keeps Interest Rates At Record Lows Amid Risks

1/9/14 12:06PM EST

ECB Keeps Interest Rates At Record Lows Amid Risks ECB Keeps Interest Rates At Record Lows Amid Risks

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Europe is still one of the most interesting places to invest. The risks in the countries using the continent’s single currency are avidly followed, and little understood. Europe is a complicated problem, and there is nowhere that is more evident than the European Central Bank. The regulatory body kept interest rates across the Eurozone at record lows this morning as the union struggles with economic risks from a plethora of directions.

The European Central Bank kept its benchmark interest rate at 0.25 percent, a record low first implemented in November. That change may have surprised investors, but this morning’s decision was widely expected. Europe, like the United States, is unable to keep its inflation rate near its target. That means the currency is at risk of deflating relative to the world’s other currency’s.

Eurozone Deflation

Eurozone inflation stood at around 0.8 percent in December. The ECB has a stated target of 2 percent, but the struggling continent is unable to devalue the single currency at anything close to that rate. Low interest rates, and monetary easing, are supposed to spur inflation. That hasn’t worked in the Eurozone, and it is a growing problem in the United States.

Deflation can lead to huge economic problems as consumers prefer to save their money rather than spend it, and economic growth remains sluggish as a result. the catalyst for deflation is very different than that which drove Japan into its period of stagflation, but analysts are worried about the fate of the single currency in a similar situation. In Europe business and households are not being given access to the credit that they crave, and the economy is not benefiting from the credit market.

Deflation could cause Europe’s long term problems to turn into a decade, or more, of officials struggling to bring the economy under their control. Europe faces risks other than deflation, however, and one of those problems could bring an end to the single currency experiment before falling prices have the opportunity to.

Risks Mount In Europe

Analysts have been taking solace from better than expected reports that emerged from the Eurozone in recent weeks. The reports show that retail sales are up, and industrial activity is also increasing. The issue, as always in Europe, is regional. Europe’s core nations are performing well. Germany’s factories are humming and its unemployment is at incredible lows.

The countries at the periphery are not performing quite as well. Spain’s unemployment is still above 25%, and the country’s future is far from predictable. At the same time France, long considered a core nation, is fast becoming a peripheral part of the continent’s decision making and economic activity.

Europe is surrounded by economic problems, and the tools available to the central bank are simply not up to the challenge. The continent may need to implement more than a single interest rate, or it might require more creative approaches to policy. Whatever the solution, Europe is difficult to predict, and investors willing to open themselves to the continent’s risks are brave indeed.


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