Rate cut by European Central Bank overdue

THE European Central Bank will meet tomorrow to assess eurozone interest rates. And it’s broadly expected that the ECB will leave their overnight refinancing rate — the rate at which they lend cash to commercial banks — unchanged at 2%, because inflation in the eurozone is currently running above target.

So variable mortgage holders can’t expect any good news from Frankfurt tomorrow.

Yet, this monthly ECB meeting might not be all that uneventful, because it could prove to be the last meeting at which the current ECB president Wim Duisenberg presides.

Since the ECB’s inception, Mr Dusienberg has steered the council that set interest rates for the 12 countries that share the single currency, with mixed success.

However, he is ending his term early, and handing over his office to Jean-Claude Trichet, governor of the Bank of France, in November.

Mr Duisenberg’s ECB was often unfairly criticised for ignoring the eurozone’s growth problems, yet the ECB is only legally required to maintain price stability.

In other words, all the ECB is supposed to do is keep inflation at or below target.

Central banks in the United States and Britain are required to stimulate economic growth, whereas the ECB is not.

But some observers are hoping that Mr Trichet’s presidency will herald a new era of proactive monetary management in Frankfurt.

Since Mr Trichet is French, analysts are reasoning that he will be more inclined to adjust rates to encourage growth, because France has blatantly ignored the European Commission’s existing rules on spending in an effort to revitalise the French economy.

However, Mr Trichet is a seasoned banker, and he was France’s chief negotiator on the single currency section of the Maastricht treaty, so it’s unlikely that he’ll want to break the rules that he effectively created.

Not immediately, at least.

All we can initially hope for from the new president is more openness and transparency from the ECB. Outgoing president Duisenberg has often been accused of unintentionally misleading the market, although communications have been improving recently.

Yet, irrespective of who is at the helm, in my opinion, we need another cut in interest rates. Earlier this month, we were told that eurozone growth in Q2 had been revised. From an original estimate of +0.1% growth, Eurostat now estimates that the 12 nations which share the euro contracted by an aggregate -0.1% in Q2.

Germany, France, the Netherlands and Italy all contracted in Q2, and need an economic shot in the arm.

Given the rules by which the ECB is bound at present, it will have to wait until eurozone inflation starts to fall again before it can even consider cutting interest rates, but I believe that a final rate cut is now overdue.

Although, as I’ve warned before, a cut in the overnight rate will only temporarily benefit Irish borrowers with variable rate mortgages; the international outlook is improving, and longer-term interest rates are increasing.

Thankfully, for the new president, if a global recovery is beginning, his term of office may eventually prove easier than his predecessor’s.

The views and opinions expressed in this article are those of the author and do not necessarily correspond with those of Ulster Bank or any other member of the RBS Group.