It seems to me the ECB should have cut...inflation is dead. I don't know why they are being so cautious.
European Central Bank Chief Hints at Rate Cut
By CARTER DOUGHERTY
Published: October 2, 2008
FRANKFURT — Jean-Claude Trichet, president of the European Central Bank, struck a dark tone about the growth prospects of the 15-nation region on Thursday, suggesting that the bank might be inclined to cut interest rates later this year.
Earlier, the central bank left its benchmark interest rate at 4.25 percent as fears over inflation continued to outweigh concerns over the financial crisis. But that bias appeared to be changing.
“Economic activity in the euro area is weakening,” Mr. Trichet said. “The economic outlook is subject to increased downside risks.”
“We discussed extensively the recent intensification of the financial market turmoil and its possible impact on economic activity and inflation,” he added, “recognizing the extraordinary high level of uncertainty stemming from the latest developments.”
The decision, which was generally expected, came as credit markets remained stalled and as European governments stepped in this week to help bail out five banks. Ireland became the first European Union country to fall into recession this month, and the likelihood of a broader downturn looms in Europe.
The central bank has been criticized for not lowering interest rates by now, but it has remained focused on inflation since the financial crisis began in August 2007 and even raised borrowing costs in July.
Nonetheless, Mr. Trichet’s comments were interpreted to mean that the central bank would be more willing to cut its benchmark rate in December, or possibly even in November. The bank’s governing council meets on Oct. 23 and again on Nov. 11.
“There are significant changes in the first paragraph with a stronger role for the negative impact of the financial crisis,” Aurelio Maccario, an economist at UniCredit in Milan, told Reuters. “Clearly there is a rather pronounced shift in the E.C.B. stance that should pave the way to the central bank cutting rates. The chances for a rate cut at the turn of the year are very high.”
Mr. Trichet and other central bank officials have argued that they can handle drum-tight credit markets — the core problem of the crisis — through billions of euros in infusions into the money markets. But the infusions have grown progressively larger and more frequent. Its benchmark rate, on the other hand, helps keep inflation under control.
Inflation has eased to 3.6 percent in the year ended in September, an improvement from the summer, when it exceeded 4 percent. But it is still far above the central bank’s goal of about 2 percent.
Whether the bank’s tactic has been successful is open to debate. Borrowing costs have soared as financial companies remain reluctance to lend money.
On Thursday, Mr. Trichet addressed inflation by saying that “Upside risks to price stability have diminished somewhat but they have not disappeared.”
The argument in favor of rate cuts is that the central bank is underestimating the impact of more stringent credit on the European economy, and it will be forced to abruptly shift gears when statistical evidence emerges of anemic growth.
“It is difficult to predict the precise impact of the financial stress on the real economy,” David Mackie, chief western European economist at JPMorgan Chase in London, wrote in a research note. “Previous experience suggests that extreme financial stress can contribute to a deep recession.”
The European economy shrank in the second quarter, and many economists expect it to do the same in the third.
“I would argue now that the E.C.B. needs to lower rates as soon as possible,” said Paul de Grauwe, a professor at the Catholic University of Leuven in Belgium. “At the very least, that avoids the need in the future for a panicky reaction, a desperate last step. I don’t think there is any reason to fear inflation.”
Oil prices have plummeted from their July high of about $145 a barrel to, on Thursday near $97, easing inflation concerns. A weaker global economy with less need for energy could push oil prices even lower, analysts say.
Investors are generally betting that the central bank will cut rates by December and that an economic recovery will be under way by the first quarter of next year. But with financial markets so chaotic, analysts had been reluctant to rule out a rate cut on Thursday, or even a coordinated effort with the Federal Reserve — something that last happened seven years ago.
“In September 2001 we saw that the E.C.B. could react quickly,” Soeren Dijohn, senior analyst at Danske Bank in Copenhagen, wrote in a research note. “Similar flexibility could be seen this time around if financial markets are perceived to be under severe strain and monetary conditions appear inappropriate.”
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