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EU: Economists Demand Reduction In Central Bank Interest Rates

  • Mark Baker

Six leading German economic research institutes have joined the chorus calling on the European Central Bank to lower interest rates tomorrow (11 April). The institutes, citing slowing growth in Germany, said the bank could reduce benchmark rates by as much as half a percentage point. RFE/RL correspondent Mark Baker looks at the pressures the bank is under to reduce rates even as inflation in the 12-nation euro-zone remains above the bank's target.

Prague, 10 April 2001 (RFE/RL) -- It's looking increasingly likely the European Central Bank tomorrow (11 April) will reduce interest rates for the euro when the bank's governing council meets in Frankfurt.

Six leading economic research institutes in Germany lent their weight to a rate cut today. They called on the ECB to slice a relatively large half-a-percentage point off the benchmark rate, from 4.75 percent to 4.25 percent.

The ECB is the only major central bank not to have reduced interest rates this year amid deteriorating economic data from the United States and much of Asia. The bank has held its main rate steady since October.

By contrast, the U.S. Federal Reserve has cut its benchmark rate 1.5 percentage points so far this year following a dramatic slowdown in the U.S. economy at the end of last year. More reductions are expected.

The six institutes (DIW, Ifo, HWWA, IfW, IWH, and RWI) said global economic conditions had deteriorated more sharply than they expected in their report last autumn and that the ECB had not reacted to the deterioration. Gustav Horn, an expert with the German Institute for Economic Research, told reporters in Berlin that price stability in the European Union is not in danger, and thus there is no reason not to reduce rates:

"The [six economic] institutes believe that a lowering of the [benchmark] interest rate of half a percentage point (to 4.25 percent) is justified. The two components of monetary policy show us that price stability is not in danger. The growth in money supply has clearly slowed down. That's the first thing. The second thing is estimates of price inflation: we see a clear easing of inflation over the time period of the prognosis. This is because of the weakening in oil prices and a stronger euro, which we stand behind."

Horn emphasized, however, that the ECB's approach to monetary policy should be different from that of the U.S. Federal Reserve, where he said officials had made a radical change in monetary policy:

"We are not recommending a radical change in monetary policy, such as in the USA, but rather a light easing of monetary policy because of the lowering inflationary pressure."

A survey of 37 economists conducted this week by the French news agency Agence France Presse shows most (29) believe the ECB will lower rates, with most of them saying a quarter-point reduction (to 4.5 percent) is likely.

Central banks typically adjust benchmark interest rates to accelerate or slow the economy as needed. Lower rates stimulate the economy by making it cheaper for businesses to borrow money.

Stefan Schneider of Deutsche Bank Research in Germany says the ECB has resisted lowering rates so far because it wants to show that it can act independently of politicians and EU member-governments in setting monetary policy. But Schneider says a raft of fresh data shows the economies of the 12-nation euro-zone are slowing. He says this leaves the bank with little choice but to lower rates.

"I mean the pressure on the ECB from the political side [to reduce rates] has certainly increased. Maybe that's one factor why, for the time being, the bank has been reluctant to cut rates. But we think the evidence that the external slowdown will have an effect on the euro-land economies is really increasing by the day."

This was to have been a second year of strong expansion in the European Union as foreign investment boomed and exports grew. But one by one, governments and research institutes have scaled back economic growth projections for 2001 amid a general global downturn.

The Organization for Economic Cooperation and Development, or OECD, today revised its 2001 growth forecast for the euro-zone downward to 2.7 percent from an earlier prediction of 3.1 percent. In its report, the OECD said economic momentum had been blunted by rising oil prices last year and the weaker euro. The OECD also said structural reform in the euro-zone was lagging.

Last week, the head of the International Monetary Fund, Horst Koehler, hinted the IMF too would lower its growth prospects for the euro-zone this year in its World Economic Outlook report due out later this month (26 April).

Correspondents say, however, that in spite of slowing growth, an ECB rate reduction tomorrow is not inevitable.

The ECB's main task, according to EU law, is not to promote growth but to control inflation.

Bundesbank President Ernst Welteke, who sits on the council, said last week that inflationary dangers in Europe had not subsided and reminded reporters that the ECB is not responsible for promoting growth. Euro-zone inflation is currently above the 2 percent threshold the ECB regards as relatively benign.

Economists also say that since economic conditions are not uniform across the EU's various national economies, achieving a consensus among the 18 council members is always difficult -- even when the case for a rate cut is relatively easy to make.

Among the world's leading central banks, the Frankfurt-based European Central Bank is arguably the most cautious when it comes to changing interest rates.

In 1999, the bank belatedly cut its bench refinancing rate in reaction to the 1998 global economic slowdown. But by the time the rate cut came, European economies were already recovering and the effect was lost.

Prospects for lower interest rates have not had a strong effect on the value of the euro, which was recently trading almost unchanged at just below 90 U.S. cents. Lower interest rates typically reduce the value of a currency as traders shift investments away from that currency seeking higher returns elsewhere.

Traders said this week they would welcome any rate reduction and that the benefits of a rate cut would overshadow any negative interest-rate effects.

The ECB's governing council meets every two weeks to discuss interest policy and other issues. If it doesn't reduce rates tomorrow, it will have another chance to do so at its next meeting 26 April.

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