Europe cuts rates at last

The European Central Bank took the markets by surprise yesterday and cut interest rates for only the second time in its history to ward off the threat of recession in the eurozone.

In a u-turn from its previous hawkish stance, the Bank cut rates by a quarter point to 4.5%, citing new evidence of money supply slowdown which made it more confident it could keep inflation in check. "It's not our policy to surprise markets, but sometimes it's unavoidable," bank president Wim Duisenberg said. "New facts lead to new assessments ."

The ECB's shock move overshadowed the Bank of England's decision earlier in the day to cut British borrowing costs by 0.25 percentage points to 5.25%, its third cut in rates this year.

Until yesterday, Mr Duisenberg and fellow members of the ECB's governing council had stood firm in the face of pleas by European and US policymakers for them to join global efforts to revive the ailing world economy. After the bank disappointed hopes that it would cut interest rates last month, Mr Duisenberg told a press conference, "I hear but I do not listen."

US treasury secretary Paul O'Neill recently said he was "mystified" by claims that Europe was immune from the sharp US economic slowdown. A top economist at the International Monetary Fund even suggested the ECB was part of the problem instead of the solution.

The message that Europe is unlikely to remain insulated from a global recession appears finally to have penetrated the ECB's Frankfurt headquarters. After its hawkish rhetoric in recent months, yesterday's decision caught markets off guard and seemed to signal the bank is backtracking.

While Mr Duisenberg insisted that political considerations played no part in the bank's decision, analysts said external pressure had almost certainly played a role.

"Precious little has in fact changed in the fundamentals over the past month," said Klaus Baader of Lehman Brothers.

Mr Duisenberg justified the sudden reversal in the ECB's stance by pointing to new data that showed monetary growth (M3) -an important indicator for the bank - was not as fast as previously thought. The ECB has also cut its view about Europe's growth prospects from above average to in-line with long term trends.

"M3 was always going to be the ECB's flexible friend, much like it was for the Buba [Bundesbank], and this revision of M3 has given it the excuse it wanted," said Nigel Anderson, of Royal Bank of Scotland.

The euro shot up half a cent in the wake of the ECB announcement, but quickly lost all its gains, as traders judged that the move was too late to prevent a slowdown in the eurozone economies. The euro finished trading in London below 88 cents, a three-week low.

Analysts said yesterday's move opened the door for further easing in coming months. A Reuters survey after the decision showed that economists expect the ECB to follow up with two more rate cuts by the end of the year.

But Ernst Welteke, the president of the Bundesbank who is a member of the ECB's governing council was quick to dispel the impression that the bank has become dovish on inflation. "This step was not a change of direction, but an adjustment in rates bringing them in line with our strategy," he said.

Links

European Central Bank
Index of production, March (pdf file)