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ECB ignores warnings and holds rates at 2%

ECB ignores warnings and holds rates at 2%
By Steve Johnson
Published: June 2 2005 12:45 / Last updated: June 2 2005 12:45

The European Central Bank held its main refinancing rate at 2 per cent for the 24th straight month on Thursday.

The decision was widely expected amid mounting economic and political turmoil in the wake of the French and Dutch rejection of the proposed European Union constitution and a deteriorating growth environment.

All 31 economists polled by AFX News and Agence France-Presse had predicted the Frankfurt-based bank would hold rates once again. While most analysts still expect the ECB’s next move to be upwards, commentators are increasingly pushing back their expectation for the timing of a first hike into 2006.

Indeed both the Organisation for Economic Co-operation and Development and Germany’s Ifo Institute last week called on the ECB to cut rates to stimulate economic growth. Interest rate futures currently factor in a 15 per cent chance of a rate cut later this year.

The OECD’s call came after the Paris-bound organisation revised down its forecasts for eurozone growth in 2005 and 2006 to 1.2 per cent and 2 per cent respectively, from 1.9 and 2.5 per cent. The OECD called for a 50-basis point rate cut to address a “chronic pattern of weak resilience”.

The Munich-based Ifo Institute spoke out after reporting that German business confidence had fallen to a near two-year low, mirroring a fall in the ZEW measure of investor sentiment.

Wolfgang Clement, Germany’s economics and labour minister, and a number of Italian ministers, also supported calls for the ECB to cut rates from their current historic low. But few analysts believed the Bank would bow to pressure to cut rates this month, with Jean-Claude Trichet, the president of the ECB, having warned that a cut would backfire, undermining growth by raising inflationary expectations.

“Whether others like it or not, the ECB isn’t an activist central bank,” said Julian Jessop, economist at Capital Economics, who sees rates being on hold for the rest of 2005. “Growth would have to be substantially weaker and inflation lower than expected to force the ECB into action.”

Mr Trichet has instead given the impression he would like to see eurozone rates rise as soon as the economic conditions allow. However, the economic picture emerging from the eurozone remains bleak.

The French economy expanded by just 0.2 per cent in the first quarter, while Italy fell into recession. Although data showed the German economy expanding by a healthy 1 per cent in the first quarter of 2005, most commentators believed this was flattered by one-off factors.

Meanwhile the eurozone manufacturing purchasing managers’ index fell below the breakeven level of 50 in April, with Mr Jessop arguing that on the two previous occasions when this measure fell into contraction territory, in 2001 and 2002, the ECB cut rates within a few months.

Furthermore core eurozone inflation has fallen to just 1.4 per cent, its lowest level since February 2001, with oil prices now off their highs and second round effects from high energy prices remaining muted.

However the 5.5 per cent slide in the euro to $1.226 against the dollar since the ECB’s last meeting may have done some of the Bank’s work for it. The weakening of the euro is stimulative to growth in the same way a rate cut would be, and, if it persists, is likely to be an upward drag on eurozone inflation.

The ECB has also fears the growth in M3 money supply, which remains around 6.5 per cent, is inconsistent with non-inflationary growth, while rises in house prices in many countries are a result of monetary policy that is already loose enough, the bank has argued.


LINK: http://news.ft.com/cms/s/d283f5d8-d1c4-11d9-8c82-00000e2511c8.html