Economists urge rate cut

MOST economists think the European Central Bank (ECB) ought to slash interest rates by a full 1%.

They thought that before the US Federal Reserve surprised the markets on Wednesday and cut rates by a full 0.5%.

However, the ECB has maintained its dog-in-the-manger stance on inflation currently 0.2% above the official target rate of 0.2%.

Markets were miffed yesterday at the stubbornness of the ECB to make some gesture towards lower rates.

Jim Power, chief economist with Friends First, said without doubt the ECB ought to cut rates by a full 1% in the coming months, but he accepts that at best this will be no more than 0.5%.

Concerns about the stability and growth pact and fears of being seen to be subservient to the US on monetary matters also influenced yesterday's decision to hold rates at 3.25%. They are unchanged since March.

Concerns that Europe could tip into recession are real and the ECB's refusal to boost the stagnant economy with a rate cut has done the ECB itself no favours, it was claimed. Austin Hughes, chief economist with IIB Bank, said the ECB damaged its credibility yesterday by admitting the situation merited a cut in rates.

Both expect that the UK and the ECB, both of which held rates yesterday, will cut them next month.

Given the sharp cut by the Fed its implication is that the threat of global economic slowdown has increased. It also begs the question of double dip recession in the months ahead, but with Mr Power forecasting growth of 2.9% for 2003 he has eliminated that possibility from his considerations. Senior UK fund managers have also discounted that possibility. Mr Hughes is scathing in his condemnation of the ECB to act in the face of mounting concerns about Europe.

Next year Mr Hughes says Europe will struggle to grow by 1.4%. It is also looking at an average inflation of 1.7% next year as the German economy slows to near standstill. So why the obsession with inflation? he asked.

Mr Power warned yesterday that Germany has the potential to derail the EU economy given that it accounts for 30% of European GDP.

Niall Dunne, senior economist Ulster Bank Markets, believes the Fed panicked and cut by a full 0.5% because the bulk of the market was expecting a sharp reduction.

Expectations also that the ECB and the UK would follow the Fed's lead were misplaced.

The Fed's reference to "geopolitical risks" seemed to broaden its concern beyond the US while also signalling deeper fears among US officials that their economy continues to struggle.

"We thought that Mr Greenspan would have been on the phone urging the ECB and the Bank of England to cut rates, based on his comments, but clearly that was not the case", said Mr Dunne.