By Max Clarke

A financial gulf is emerging in Europe between economically failing states, as Portugal joins Greece and Ireland to become the third country in need of an EU bail out, and Germany, whose economic strength is almost single handedly propping up the EU.

Following today’s announcement that the European Central Bank has decided to raise interest rates by 0.25%, Chris Towner, director of FX Advisory Services at HiFX discusses with Fresh Business Thinking how this will affect Europe.

“A two-tier Europe continues to emerge with Portugal being the third country to require funding from the EU bail-out fund. The last couple of days have proven that Europe is very much divided in two with Portugal joining Greece and Ireland in need of aid, while Germany is continuing to power ahead with two consecutive months of strong manufacturing orders and unemployment at a two-decade low.

“It is the core of the EU that required today’s interest rate hike of 25bps to 1.25%; whereas the peripheral economies require further loosening. Inflation rates have pushed up in Europe to 2.6%, above the European Central Bank’s (ECB) 2% target rate, meaning swift action was required.

“It is important to note that this inflation gap and the reaction of the money markets to Portugal’s downfall could turn into an issue for the core European economies. In contrast, when Greece required aid last year, we saw the EUR/USD drop from just below the 1.40 level to trade briefly sub 1.20. This gave German exporters the opportunity to benefit from the woes of the Greeks by making their pricing more competitive and boosting the German economy. The issue now is that while the Germans have reaped the rewards of a more competitive currency, they are now seeing the Euro trade far more resiliently to bad news and therefore German exports are becoming less competitive as the Euro rises. This is not a great combination for Germany, the only pillar that is holding Europe up! On top of this the intervention from the G7 countries to curb the rise of the Japanese yen will open up more competition from Asia.

“So the one advantage the UK can take from not raising rates is that Sterling continues to trade in under-valued territory and an opportunity for UK exporters to grow market share”.