Shared euro interest rates may spell trouble for some European Union members that are unable to customize interest rates to boost or temper the country’s individual economy. Spain, for example, is facing an impending economic crisis but is unable to lower interest rates to keep its economy moving forward and avoid a crash.
Spurred by the euro’s low interest rates, the Spanish property market has experienced rapid price appreciation in recent years. House prices in Spain have risen 14 percent in the last year, 57 percent in the last two years and 100 percent in the last five years, according to an August 2007 report by Halifax and European Central Bank.
Such rapid growth is likely not sustainable for long, and problems with oversupply of inventory appear likely to cause a bust in the Spanish property market. The Finance Ministry announced that Spanish construction companies built 750,000 houses and apartments last year, more than France and Germany combined, while annual demand is running about 60 percent of that level, according to the International Herald Tribune.
Increasing interest rates will hurt demand for properties further, deterring investors and buyers. Most Spaniards have variable-rate home loans, and the euro interest rate increases have boosted defaults, according to Bloomberg.com.
In contrast, Germany’s needs are quite different. German banks have been “extremely cautious and quite conservative” since Germany’s reunification boom and bust, Julian Power of Berlin Capital Ltd. said. Because German lenders are more conservative, fixed-rate mortgages are more common and larger down payments are required. With less risky leverage and fixed rates, German property owners suffer less when interest rates rise.
Because Germany is the largest economy in Europe, it has the largest influence over the euro’s interest rates. With a booming economy, Germany will benefit from increasing interest rates in an attempt to limit inflationary bubbles and slow the pace of growth.
Spain, on the other hand, would prefer rates be lowered in order to cushion its economy from an impending crash. Without the ability to control its interest rates, Spain has no way to restore balance to its economy and will remain helpless as its economy faces a probable recession.
When interest rates are shared between economies as dramatically different as Germany’s and Spain’s, there is no way to please everyone. And with 11 other countries and their needs factored into the mix, interest rate decisions become even more complicated; Austria, France, Finland, Ireland, Slovenia, Belgium, Greece, Italy, Luxembourg, the Netherlands and Portugal are other E.U. members that use the euro.
Other current and future E.U. members are also planning to shift over to the euro in coming years. Some non-E.U. countries also use the euro, which means their economies are also affected by euro monetary policy decisions even though they have no say in those decisions.
Each of these euro-based economies is unique and has its own needs, so it’s hard to set interest rates that will benefit each country. Germany appears to be the pace setter for interest rates, so investors considering investments into euro-based economies will do well to consider the economy of that particular country and how it may be affected by interest rate decisions that will not be made for the sole benefit of that country.