Fed rate cuts will not sway European counterpart

GIVEN the US has slashed its key interest rate five times since August 2007 to 3% from 5.25%, many people are puzzled by the failure of the ECB to follow suit.

The US has cut rates by 2.25% since August to prevent a big recession.

Britain cut rates by 0.25% yesterday for the second time in three months while Europe’s central bank again held rates at 4%, the level they have been at since June.

It warned that the threat to inflation still remains a concern and will remain a priority for the bank.

Inflation in the 15-nation eurozone hit 3.2% in January, the highest level since the single currency was launched.

Last September the ECB was set to raise its benchmark rate to 4.25% but held off as the credit crunch threatened to spark recession in the US that would result in slower global growth.

That decision was significant given the bank had signalled at its August meeting it was about to raise rates the following month.

After the bank’s warning yesterday that price inflation remained a dominant concern the chances of it taking a lead from the Federal Reserve have receded.

In reality the two leading central banks operate to different mandates.

The Fed is obliged to use interest rate policy to strike a balance between economic growth and inflation.

By contrast the European bank has just one mandate — to keep inflation close to, but below, 2%.

With inflation still rising, Europe’s central bankers have little wriggle room.

It is faced with a dilemma with rising inflation on the one hand and the threat of economic slowdown on the other, demanding two different rate responses.

But the emerging global economic slowdown may resolve the ECB’s dilemma, a point noted by the ECB when it warned that uncertainty about growth in the eurozone economy was “unusually high”.

Thomas Mayer, economist with Germany’s leading Deutsche Bank, said the critical Purchasing Managers Index is starting to fall.

Recognised as the critical indicator of economic growth, recent surveys suggest European growth is slowing, he said.

If that process speeds up in the next two months, Mr Mayer said a cut in rates could become a reality by April.

However the warnings on price pressure from the ECB yesterday suggests the rate cuts may not start to happen until the second half of the year.

Jean-Claude Trichet reiterated the bank’s position yesterday when he said keeping inflation anchored remained “the highest priority” of the central bank.

He added that the decision to keep rates on hold “reflects our assessment that risks to price stability over the medium term are on the upside”.

Mr Trichet also reiterated his warning about wage settlements in labour negotiations under way in Europe.

The ECB is concerned that pay increases will force inflation higher in the medium term.

Its refusal to move on rates is also seen as a warning to unions that it will raise rates if their demands are excessive.