Bank of England cut interest rates by 25 bps in response to the slowing of the UK economy to 5.25 percent. This is still high relative to the US even though Great Britain has been matching US behavior. The ECB, on the other hand, has continued to stay focused on its inflation target goal and kept interest rates unchanged at 4 percent. Inflation is currently above target in Euroland and is at a 14 year high.
An important theme to watch is how inflation target central banks behave in 2008. The Fed has a dual target of maintaining price stability as well as continued growth in the economy. A number of central banks do not have this dual objective but a single inflation goal. The market for Euribor seems to be suggesting that the ECB will cave on their inflation goal. It is showing rates at 3.49 for the December. If the inflation target banks do not change their behavior we will see growing divergences in interest rates which should lead to greater divergences in growth and bigger adjustments in currency markets.
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