2011 predictions: interest rates around the world

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2. Eurozone: Sovereign debt woes still plague euro

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    An assistant holds a shopping bag with a euro symbol during arrivals for an EU summit in Brussels, Thursday, Dec. 16, 2010. Disagreement among nations over how to fight Europe's debt crisis could limit the European Central Bank's ability to raise interest rates.
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The European narrative in 2011 will revolve around the ongoing debt crisis. So far, the governments of Greece and Ireland have received tens of billions of euros to stave off bankruptcy. Their economies are small enough – gross domestic products of €237 billion ($311 billion) and €163 billion respectively – that they won’t rock the European Union, with a GDP value of nearly €12 trillion. But what if a larger European economy finds itself at the mercy of its creditors?

In mid-December, a key ratings agency threatened to downgrade France’s credit rating if it did not address its overspending. This same scenario happened in Ireland and Greece – will France play out the same way? If so, we can expect the warnings to be followed by an actual credit downgrade. The loss of investment-grade status added dramatically to the cost for Ireland and Greece to borrow money, precipitating a further downward spiral. A similar ratings downgrade for France, the eurozone’s second-biggest economy, would surely spark a much more serious euro crisis. Even a downgrade for troubled Spain could force the European Union to come up with a much larger rescue package that European taxpayers would have to fund.

A spurt of economic growth would ease these debt worries and offer some support to the euro. Unfortunately, growth in most of the Eurozone countries is decelerating. The fact that Germany is single-handedly keeping the Eurozone afloat further complicates the situation. As an exporting nation, Germany has benefitted from a weaker euro. But an interest rate increase could neutralize Germany’s advantage. Thus, even if the value of the euro begins to slip badly, the European Central Bank will be hard-pressed to implement a rate hike until the economy shows a marked improvement.

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