CNN: Europe Holds Firm Against Rate Cuts; Investors Skeptical
January 23, 2008: 08:05 PM EST
Jan. 24, 2008 (Investor's Business Daily delivered by Newstex) --
Steadfast or just stubborn? A day after the Federal Reserve slashed rates in an emergency move, the European Central Bank tried to squash any talk that it would follow suit.
ECB President Jean-Claude Trichet on Wednesday stressed that inflation concerns are paramount, even amid fresh signs of slowing euro zone growth.
"It is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility" in financial markets, Trichet told a European Parliament conference on financial supervision.
European investors begged to differ, sending the major bourses into or near bear market territory. The German Dax dived 4.9% on Wednesday as British stocks slid 2.3%.
Despite Trichet's hawkish tone, futures traders raised their bets that the ECB eventually would follow suit.
U.S. stocks sold off hard, but rallied for solid gains late in the day. The Dow rose 2.5%, the S&P 500 2.1% and the Nasdaq 1.1%.
Trichet didn't mention the Fed's unexpected decision Tuesday to slash the fed funds rate by 0.75 percentage point 15 3.5%, the biggest rate cut in 23 years.
The Fed cited increasing downside risks to growth as reasons to act before its scheduled meeting next week.
The ECB's decision to stand pat reflects its sole mandate: Keep a lid on inflation.
By contrast, the Fed is tasked with curbing inflation while also promoting full employment.
The U.S. jobless rate hit a two-year high of 5% in December, while recent data have shown declines in factory activity and retail sales. That has raised fears of a U.S. recession among investors worldwide.
"The U.S. is much closer to a recession than Europe is," said Jay Bryson, global economist at Wachovia. (NYSE:WB)
European growth is expected to slow to 2%, but there's no talk of recession there yet. Meanwhile, euro zone consumer prices rose 3.1% in December, well above the ECB's 2% ceiling.
While prices are expected to fall within the ECB's target zone by year-end, the central bank has refused to cut rates to bolster the economy.
Some say the ECB is behind the curve in dealing with the fallout from a global credit crunch and the slowing U.S. economy. Just as Europe's recovery lagged America's, so might its decline.
"It's a grave mistake that the ECB isn't following suit because this is a global economy and they're by no means immune from this," said Richard Yamarone, chief economist at Argus Research.
Meanwhile, many analysts say the Fed has the opposite problem. They criticize the timing of the central bank's surprise move, which followed steep declines in global stock markets and gave the impression that the Fed was panicking in response to investor fears.
"They (Fed policymakers) have to say where they're going and then get there and stop," said David Kelly, JPMorgan (NYSE:JPM PRH) (NYSE:JPM PRX) (NYSE:JPM PRK) (NYSE:JPM PRJ) (NYSE:JPT) (NYSE:JPM) Funds' chief market strategist. "Until then, financial markets are going to be pretty rocky."
The Fed's rate cut cheered Asian investors. Hong Kong stocks soared almost 11% after the central bank matched the Fed's rate cut. Stocks in Tokyo, Shanghai and Jakarta also rose.
Futures traders overwhelmingly expect the Fed to lower borrowing costs by another 50 basis points at its Jan. 29-30 meeting.
Trichet called for changes to banks' risk management and better supervision of mortgage brokers after a spike in subprime loan defaults that has prompted banks to restrict credit, threatening the global economy.
Euro zone service sector growth slowed in January to the lowest rate in more than four years, RBS/NTC said Wednesday. Manufacturing growth was steady, but the strong euro, high oil prices and the slowing U.S. economy bode ill for European factories.
If Europe loses a lot of steam, that could take out one of the last supports for the U.S. economy, which has benefited from strong European demand for American goods.
"We had hoped that export orders would carry us through to the latter part of 2008 when we'd see the interest rate cuts from last year take effect," said Bruce McCain, head of investment strategy for Key Private Bank. "That now looks like it won't be the salvation we had hoped for."
Newstex ID: IBD-0001-22477680
Originally published in the January 24, 2008 version of Investor's Business Daily.
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