ECB to stand firm on rates, despite economic fears

 

  

Faced with record inflation, the European Central Bank should resist pressure for an interest rate cut in the wake of moves by the US Federal Reserve when the ECB governing council meets this week.

 

Despite a spectacular decrease in US lending rates and growing concern over the 15-nation eurozone economy, the ECB was set to keep its main rate at 4 per cent, where it has been since June, when council members meet on Thursday.

 

It does not feel the time has come to cut the cost of borrowing, or even to signal that a cut is in the cards, contrary to the Bank of England, which economists expect to ease its main rate the same day.

 

"ECB president Jean-Claude Trichet will show more concerns about the economy," said Commerzbank chief economist Joerg Kraemer. But that would be it.

 

"At the same time, he will warn about the risks of inflation, as he did at the beginning of January, and stress that the ECB is ready to act" to counter them, a way of threatening tighter monetary conditions, Kraemer added.

 

Eurozone inflation hit 3.2 per cent in January, fueling concern over the loss of purchasing power in Europe. Trade unions, especially in Germany, see it as a good reason to press for significantly higher wages.

 

But the ECB, which considers inflation to be under control if it remains just below 2 per cent, is worried that stiff pay increases will create long-term inflation.

 

Given its primary mission of guaranteeing price stability, the bank is likely to reiterate its warnings, said Holger Sandte of WestLB bank.

 

But words seem to be the only weapon at its disposal. Raising rates would be nearly impossible as the United States flirts with recession and the eurozone begins to pay the price.

 

Recent drops in business and consumer sentiment are an umistakeable sign of the times.

 

If the ECB holds firm, it will undoubtedly be the target of more pressure, in particular from countries like France.

 

Luxembourg Finance Minister Jean-Claude Juncker, who chairs the Eurogroup of finance ministers, had diplomatically added his voice to those who call for a change in policy.

 

After formerly seeking to reassure the public about the health of the eurozone economy, Juncker now has begun to worry about risks to eurozone exports from a growing gap between US and eurozone interest rates.

 

The US Federal Reserve has carried out two spectacular interest rate cuts in eight days, bringing its Fed funds rate down from 4.25 per cent to 3 per cent and has left the door open to further decreases.

 

The Fed had sought to calm financial markets that fear the US economy is headed into a recession.

 

Maintaining its own rate at 4 per cent would mean the ECB is exacerbating the euro's external value and making eurozone exports more expensive.

 

In the end, the eurozone economy would suffer, and the ECB cannot row endlessly against the tide since the US subprime housing debacle has caused dark clouds to accumulate on the horizon for the entire global economy.

 

Last week, the International Monetary Fund sharply reduced its 2008 growth forecasts, citing a US slowdown and financial market turmoil.

 

When signs of decreased activity have become more tangible in the eurzone, and inflation has begun to ease, the ECB will begin to move towards lower rates, most economists forecast.

 

They could come as soon as the second quarter of this year, some say. (AFP)