ECB slips up with figures

The European Central Bank suffered a further blow to its credibility yesterday and opened the door for more interest rate cuts with the admission that a signficant measure of future inflation is more flawed that it had thought.

Officials last week admitted that its measure of money supply, a component in its interest rate-setting process, was half a point too high. Now the ECB admits it may have overstated the figure by a whole point.

Although bank officials are seeking to limit the damage, the news will add to pressure for further cuts in borrowing costs.

The ECB's latest problem centres on M3 - a broad money supply measure which is seen as a guide to future inflationary pressures. The ECB's mandate is to achieve price stability and M3 is one of the two pillars of the bank's interest rate-setting strategy. The other is an assessment of the outlook for inflation, which looks at factors such as wages, economic activity and the exchange rate.

The ECB took financial markets by surprise last week with a cut in interest rates even though actual inflation - at 2.9% - was above the 2% ceiling of its target range. The bank justified the cut by arguing that it believed M3 - which was also above its 4.5% target - had been overstated by around half a percentage point. At the time the ECB acknowledged that a further "not negligible" revision would be necessary but said the change was "not expected to show the same dynamics".

However, in its latest monthly bulletin the bank admitted that the second revision would be of a similar size to the initial revision.

Analysts Mike Lenhoff and Simon Rubensohn at broker age Gerard noted the ECB had always stressed the importance of the money supply numbers in setting interest rates. "If money is not driving policy (despite all the rhetoric) it is hard to know what is. The real risk is that the ECB's credibility will be further tarnished.

"While previously it may have had to withstand opprobrium from many quarters, it was at least able to point to a clear methodology. If this is stripped away, the markets may really begin to believe the Emperor has no clothes."

Yesterday an ECB spokesman defended the use of M3. It was not a question of the data being inaccurate but of the way in which the bank defined M3. The ECB was changing the definition "in order to refine the correlation" with price developments, he said.

The revision to the money supply numbers suggests that the actual growth rate is now around 4%, well below the ECB's target - giving the bank further scope to cut rates from the current 4.5%.

Commerzbank senior economist Ralph Solveen said the debate over M3 was a smokescreen and the real argument was that the ECB was more pessimistic about the European economy than it would like to acknowledge. Mr Solveen thinks the bank will lop another half-point off rates.

• The latest evidence from the US suggests the Federal Reserve's recent spate of cuts may be coming to an end. Figures released yesterday show the US trade deficit registered its largest monthly increase in almost nine years in March as American consumers continued to buy imported goods in spite of the economic slowdown.

Economists were surprised by the size of the monthly increase - a record $4.3bn rise to $31.2bn. Imports rose 2.9% in March; exports fell 1%.