ECB rate cut seeks to protect fragile eurozone

The European Central Bank yesterday admitted that eurozone economies were too weak to withstand the surging single currency, when it cut borrowing costs to a record low of 2%.

On the day of the cabinet's critical meeting on whether Britain should join the eurozone, the disparity between the UK and mainland Europe was highlighted by the Bank of England's decision to leave UK borrowing rates at 3.75% for the fourth month in a row.

With the spectre of deflation looming over Germany, the eurozone's largest economy, and latest data showing output stagnant in the first quarter, the ECB dropped a hint that further cuts could follow.

"If the United States has even lower rates than we have, you can imagine we have not exhausted our room for manoeuvre," Wim Duisenberg, the ECB's president, said.

The ECB's third cut in six months takes borrowing costs in the 12-nation eurozone to the lowest ever in any member country since the second world war. Eurozone borrowing costs are still 75 basis points higher than in the US where the Federal Reserve has been fretting for months over the dangers of falling prices.

Fresh evidence of the continent's economic malaise came yesterday morning when the European commission forecast stagnation at worst and 0.4% growth at best in the second and third quarters for the 12-nation eurozone - uncomfortably near to recession. The Eurostat figures showed Germany and the Netherlands have already experienced two consecutive quarters of contraction, the textbook definition of recession.

Mr Duisenberg warned that growth in the first half of the year is likely to be sluggish and will pick up only modestly next year. He predicted that inflation would ease to well below the ECB's 2% ceiling but denied that deflation was a threat, arguing that falling prices in one country were not a problem in a monetary union.

"We are convinced that we don't have to prepare ourselves for deflation because we don't see deflation coming. That is what I have said loud and clear. Within a monetary union, deflation is not a meaningful concept when applied to individual regions."

British industry leaders welcomed the ECB's decision but expressed disappointment that the Bank of England had not given exporters a double boost by cutting rates at home yesterday.

"The weight of evidence since the start of the year has pointed to a slowdown in the UK and, whilst there is little the Bank can do about world markets, there remains a strong case for action to promote growth and confidence at home," said Stephen Radley, chief economist at the Engineering Employers Federation.

The monetary policy committee voted 5-4 to hold rates last month and City analysts predicted that the minutes of yesterday's meeting will reveal another closely fought decision.

"Despite the failure of Sir Edward George to give a parting gift to manufacturers, money markets continue to believe that a further easing in policy is likely over the coming months," said Simon Rubinsohn, chief economist at Gerrard. "We have consistently argued that the most likely timing of another move is August."