Last week the European Central Bank raised the interest rate on the euro by 0.25 per cent to 1.25 per cent. The last time rates had been raised was in mid 2008.

Thus we have grown so much accustomed to low interest rates that even this small increase generated concern among most people, be they consumers, be they investors.

This concern became stronger as economic analysts are now predicting that by this time next year, interest rates would have risen by a full one percentage point. In support of this prediction is a statement by Jean Claude Trichet, the President of the European Central Bank, who said that even at 1.25 per cent, the interest rate is still too low.

The concern arises from three aspects – the current high level of unemployment in several leading economies, the purchasing power of consumers and the still uncertain international economic environment.

Mr Trichet expressed his dismay at the end of the EU economic and finance ministers meeting held in Budapest, that unemployment in the Euro zone was still too high, and described it as unacceptable. He claimed that although some countries have experienced an increase in employment, the situation in other countries is still very critical.

He then reinforced his view that sustainable economic growth can only occur if structural reforms are undertaken and if the fiscal deficits in various countries are addressed. Will this increase in the interest rate have a negative impact on the growth in employment?

One may rightly conclude that on its own, this increase will not hinder the growth in employment. In this regard, there should be no doubt that structural reforms are still required and as is a sane fiscal deficit. Both structural reform and judicious public expenditure will free up resources and open up opportunities for the public sector. However, it is expected that businesses will have to face an additional cost on their borrowing, and with the reduction of corporate profits to wafer thin levels as a result of the international recession, this increase in the interest rate may tilt the balance.

Governments will also be facing higher finance costs to service the public sector borrowing requirement and this may divert scarce resources from productive activities.

The aspect of the purchasing power should not be ignored. Consumers are already faced with higher petrol bills and water and electricity bills. Thus purchasing power has already taken a knock. The increase in interest rates will mean higher costs for those households that have a house loan with a variable interest rate, giving a further knock to purchasing power.

A quick basic calculation would show that on €100,000 loan, every increase of a quarter per cent (as this last one was) would mean an increased charge of €250 annually (an additional €21 a month).With the increase in the prices of commodities, and therefore also foodstuffs, the problem could be further accentuated. We could be facing the prospect of high inflation, as we faced in the first half of 2008.

The third aspect that needs to be considered in relation to the interest rate increase is the uncertain international economic environment. The ECB has recognised that the disaster in Japan and the conflicts in North Africa are bound to have a negative impact on economic growth. Add to this rising inflation (the rate increase by the ECB was in response to rising inflation), the need for further fiscal consolidation, the fact that economic growth is not being shared by all countries, the pressure on the Euro because of the large fiscal deficits of countries such as Greece, Ireland, Portugal and Spain, and one can start to appreciate that any change may create an imbalance.

What are the implications for Malta from all this? We can certainly not be very bullish about the future. Fiscal prudence continues to be a must, and so is good governance in general. If at all possible, we must maintain a balance between employment generation, consumers’ purchasing power and a sustainable fiscal deficit. It is certainly not easy to maintain this balance and we cannot afford to divert our attention from the economy to some other far less important issue.