The ECB is this week expected to lift rates by 25 basis points in a bid to reign in inflation despite ongoing fears over the financial health of Portugal, Ireland and Greece.
The decision, according to Carl Weinberg, chief economist at High Frequency Economics, is a very bad one.
“Raising interest rates will push up the cost of borrowing for euro land’s troubled PIIGS. The PIG subgroup is, to be blunt, failing before our eyes,” Weinberg wrote in a research note.
“Portugal is at risk of failing to redeem a coupon on April 15th. The cost of Ireland’s banking sector bailout is exploding… Greece is teetering on the verge of failing to make its IMF program targets,” he added.
“If Greece fails to achieve its revenue targets— again — the IMF and European Financial Stability Fund could pull the plug on its funding within the next month. This hardly seems like a good time to raise interest rates, eh?”
Banks and the Nightmare Scenario
Weinberg believes European Central Bank President Jean-Claude Trichet’s decision to hike rateswill have no impact on headline inflation but warns it could be the tipping point for a euro zone banking crisis.
“Activity at the ECB’s short-term borrowing window last week revealed that 174 banks could not borrow enough cash from the markets to realize their minimum reserve requirements,” said Weinberg.
His view is that even a 25 basis points hike will raise the cost of funding for these troubled banks which cannot access money in the open market. “The hardest hit banks in euro land will feel substantial pain.”
“A widening circle of bank failures is the triggering mechanism in our nightmare scenario for an explosion of the sovereign debt crisis into a disaster,” he warned.
“Beating a dead horse — we see the euro land’s economy as a dying horse at best — will not achieve positive results,” Weinberg added.