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We must prepare for a future shock

Article by Fine Gael MEP Brian Hayes published on the 4th October in the Sunday Business Post.

Ireland knows all too well the dangers of international economic shocks. As a country we have suffered as much economic pain from the financial crisis as almost any other country in the world, save Greece. Being prepared should be our economic motto from now on. Being prudent should be our approach going forward.

The global economy is coming into a very important moment where the central banks of some of the largest economies are setting themselves up for their first interest rate rise since the onset of the financial crisis.

If we look at the global picture – the ECB’s interest rate is 0.05%, the Bank of England’s is 0.5% and the US Fed’s is 0.25% – there is currently a general state of equilibrium in interest rates. However, both the US Fed and the Bank of England are expected to raise interest rates in the coming months. It was expected that the US Fed would increase rates in September but this did not happen, largely it seems, due to China’s economic downturn. Nonetheless, in all probability the Fed will hike rates before the end of the year with the Bank of England following suit. Such action will have a major impact on Ireland and could present both dangers and opportunities.

In the Eurozone, we are a long way off an interest rate hike due to the ECB’s ongoing quantitative easing programme which intends to have the opposite effect to an interest rate rise and expand struggling Eurozone economies. Ironically, Ireland’s position as the fastest growing economy in Europe could warrant an earlier interest rise. Likewise, conditions in Germany would be more than favourable for an interest rate hike as an economy with consistent growth and low unemployment. It is no secret that the Bundesbank has been pushing the ECB to take action sooner rather than later. But as we know, the ECB sets the benchmark rate for Eurozone countries and this is not going to change anytime soon.

Analysts widely expect that an interest rate hike in the US would cause the euro to plummet against the dollar. This gives Ireland a good opportunity as an export-oriented economy to export goods cheaply. However, at the same time, higher interest rates will prevent US banks and companies from availing of cheaper funds which could in turn caution firms to slowdown US investment into. We could also see a similar dynamic when the Bank of England raises rates.

It is important that the government is well prepared for rising interest rates. When central banks raise interest rates, the objective is to tighten monetary policy and increase inflation. Because Ireland is so interconnected with the US and the UK, the effects of their monetary policy will spill over into Ireland and will have an impact on how much we produce and how much we export as well as the price of goods. Therefore, any attempt to tighten the US or UK economy will most certainly be felt in Ireland. The financial crisis demonstrated how exposed Ireland was to downturns in other parts of the world.

There is also a major issue looming over global debt levels. Combined public and private debt has climbed sharply since the onset of the financial crisis and now stands at 265% compared to GDP for the developed economies. Much of this debt is in US dollars. Quite worryingly, off-shore borrowing in US dollars has reached a record $9.6 trillion due to low interest rates and the Fed’s Quantitative Easing. This is going to be set for a hit as the Fed raises interest rates and puts a squeeze on the dollar.

All this uncertainty has the potential to spill over into our economy. Because this is in the hands of the markets, there may be little we can do to directly control the effects of interest rate hikes on the Irish economy. But we need to be fully focused on bringing the country’s debt levels down. It cannot be underestimated the importance of having our house in order. We saw how quickly the Chinese downturn came upon us and that is what can happen with international shocks.

The government is striking the right balance in their approach to the upcoming budget and this has been backed up by the Fiscal Advisory Council. We have much work to do to get the recovery to all parts of society but we are broadly on the right track. If we keep up this momentum, we will be better able to deal with external economic shocks.

 

 

 

 

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