Interest rate cuts — too little, too late?

THE ECB interest rate ought to be a cause for concern for those with an eye on the bigger picture.

One of the main reasons the European Central Bank cut rates by 0.5% on Thursday was because of growing concern with the state of the eurozone economies.

Germany's current state of under-performance is becoming a source of major concern and many regret the length of time that the ECB took to wake up to that reality.

Most objective observers believe the ECB ought to have adopted a similar stance to the US Federal Reserve long before now, and cut rates more vigorously than it has done.

But until Thursday it prided itself on confounding forecasters as to its intentions.

Irish economists have argued that the ECB kept rates on hold too often over the past 18 months, just to keep the markets guessing, when it was increasingly obvious that lower rates were vital to counter the slowdown in the eurozone.

Even at its current 2%, the key ECB rate is still 0.75% higher than the US figure and there is a good chance that will be cut again if the economy continues to stall.

One of the ECB's problems is that its mandate is to keep inflation at or as close to 2% as possible, and so far that is what it has done despite the fact that deflation became a bigger threat as time wore on.

It is still somewhat puzzling as to why the ECB chiefs decided to focus on keeping the threat of rising prices at bay, at a time when the euro zone economy was in worse shape than the US, despite the problems foisted on that economy by the bursting of the dot.com and hi-tech bubbles.

Recent comments by German politicians have indicated a final acceptance that their economy, responsible for one-third of the EU's total output, is facing its worse financial crisis since 1945.

As things stand, it is in danger of breaching the EU's budget deficit rules again in 2004.

Unemployment is close to 11% and the economy only just avoided officially going into recession in the last quarter of 2002 and Q1 of this year. Growth stalled in Q4 of 2002 and could only manage 0.3% for the first three months of this year.

Had it stayed at zero or less in the first three months of this year, Germany would have been officially in recession, according to the accepted definition of zero or sub-zero growth in two consecutive quarters.

Given Germany's dominance, and indeed the stated concern of the International Monetary Fund that deflation was a major threat to the German economy, one wonders where the ECB has been over the past 18 months.

Earlier this week, Mr Duisenberg dismissed the IMF's comments on Germany as unfounded.

But to any outsider looking in at the ECB's mode of operation since the economic slowdown began, it is clear it could learn a trick or two from the Americans on how to use monetary policy as a tool to keep economic performance positive against the odds.

To most forecasters it has been obvious for some time that the US will lead any global recovery, and that Europe will struggle for some time to come.

And while it is obviously important that central banks should not be totally transparent to the markets, the contrast with US Federal Reserve chairman Alan Greenspan's handling of US monetary policy is clear.

That is not to imply that the US is out of its current slump: far from it.

Some indicators are pointing to better times ahead, but then some indicators nearly always do.

The big question is when will economic growth become a reality again.

Stock markets in the US are at 11-month highs, and that is better than many sceptics thought possible just a few months ago, as the Iraq war unfolded.

There are signs too that US consumer confidence is beginning to move upwards again, but how much of that is just due to post-war relief still has to be determined.

The dollar fell further after the ECB cut rates, an unexpected development which suggests that markets are not behaving to plan.

Talk of a V-shaped US recovery is however finished.

The general view is that the biggest economy in the world will do well to chug along at growth rates of 2-3% over the next 12 to 18 months, provided it does not slip back into recession.