For investors, ECB still plays second fiddle to the Fed

LONDON – European financial markets had a shakeup on Friday when the European Central Bank chief effectively told them that interest rates are going up, but for many investors it is what the Federal Reserve does that counts more. ECB President Jean-Claude Trichet all but said directly that interest rates would rise by a small margin next month – comments that, not surprisingly, lifted the euro against the dollar and hit bonds. More unusually, the comments also pared gains on Europe’s high-flying stock markets. Bourse dealers have mostly been leaving rate talk worries to foreign exchange and debt market dealers. Investors, however, reckon that Friday’s stock hiccup – which still left equities steaming ahead around 3-1/2 year highs – will not be a lasting ailment. European companies, and hence stocks, they argue, are barely tied to modest ECB rate movements and far more vulnerable to US monetary policy. The primary reason is that many large European companies are global in nature and therefore far more sensitive to movements in the world-leading US economy. It is part of the reason that European stocks have managed stunning gains this year at the same time that the eurozone economy has languished. «So much revenue from European companies is not European-rate sensitive,» said Gavin Rankin, head of investment analysis in Europe for Citigroup Private Bank. The Fed is expected to continue raising rates into 2006 reaching perhaps 4.75 percent, 75 basis points above current levels, before stopping its tightening cycle. Many investors are predicting that moment to be positive for stocks as it will remove whatever concerns there have been about how long and how far the Fed will go. The flip side is whether the Fed has paused because the dominant US economy has been hauled in too far. «Given that the US is the consumer of last resort, the Federal Reserve, by continuing to raise interest rates, is clearly trying to control the US labor market, the US housing market and the growth in consumer spending,» said Richard Batty, investment director at Standard Life Investments. An ECB rate hike is much more likely to have an impact on the euro and eurozone government bonds, but even here, the impact is linked to what the Fed does.

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