Pot shots and warning shots
[A good read on the euro rate debate - mish]
Mar 3rd 2004
From The Economist Global Agenda
The European Central Bank has come under pressure from politicians to cut interest rates when its governing council meets this week. Will it listen? Should it?
THE great European rate debate has turned. For many months, as euro-area inflation lingered above the 2% ceiling policed by the European Central Bank (ECB), politicians, traders and pundits wondered when the ECB would raise interest rates. Now, after inflation fell well below that ceiling last month, they are asking themselves, will it cut them? Some of Europe’s most powerful politicians have moved from asking to telling. Gerhard Schröder, Germany’s chancellor, and Jean-Pierre Raffarin, France’s prime minister, both called on the ECB to cut interest rates last week. When the ECB’s governing council meets to decide rates on Thursday March 4th, how will it resist such pressure?
Quite easily. The ECB, ensconced in its tower in Frankfurt, far away from any national capital, is probably the most independent central bank in the world. It is obliged to care about price stability über alles, and free to set whatever interest rate it deems necessary to achieve that goal. Indeed, it may be because the ECB’s independence is not seriously in doubt that Europe’s political leaders feel emboldened to petition it so directly. They hope to deflect some political heat to Frankfurt, secure in the assumption that the ECB can stand it.
What the politicians tell the ECB matters less than what the numbers are saying. For many months, despite sluggish growth and a strengthening currency, inflation remained stubbornly above the 2% ceiling. That made it difficult for the ECB to contemplate cutting rates, however much noise the politicians might make. With inflation falling to an estimated 1.6% in February, its lowest level for four years, a rate cut suddenly looks more plausible.
Of course, the ECB does not respond to one month’s figures—it looks for underlying trends. Nor does it respond to last month’s figures—it has to look ahead. Some analysts, such as those at Goldman Sachs, think the dip in inflation will prove short-lived. This time last year, food was particularly expensive, because of frost damage to crops, and energy prices were much higher in euro terms: oil was over €30 ($32.40) per barrel, compared with about €24 now. Core inflation (excluding the ups and downs of these volatile prices) remains stubborn at 2%, according to Goldman Sachs. The euro has also fallen back from its new-year highs, trading at less than $1.22 on Wednesday.
But there are disturbing signs that some of the air is going out of the sails of the euro-area recovery. In February, the Ifo index of German business confidence fell for the first time in ten months. Wolfgang Clement, Germany’s economy minister, called it a “clear warning shot”. A second warning came from the monthly survey of purchasing managers in euro-area manufacturing firms, who reported that new orders for their goods were coming in at a slower pace than a month before. A similar survey of services firms also found businesses losing momentum, not gaining it as one would expect in the early stages of a recovery.
This is bad news for Mr Schröder. He has staked his political fate on a set of structural reforms of the labour market, pensions and health care, dubbed Agenda 2010. So far, he has prodded a few sacred cows, limiting the duration of unemployment benefits, for example, but he has precious little beef to show for his efforts. As the name implies, Agenda 2010 was always meant for the long term. But unless he shows results soon, the chancellor may never get to the end of the agenda. His party faces 14 state, local and European elections this year. It has already lost the first of them, going down to a devastating defeat in a local election in Hamburg at the weekend.
All of this is nothing to do with us, say the great and good of the ECB: Germany’s problems are structural, not cyclical; even if the ECB wanted to help, it couldn’t. A quarter-point interest-rate cut would not free up Germany’s labour market or shore up the finances of its health system. But this clean distinction between cyclical and structural factors exists only in theory. The fear is that by damaging confidence, sowing insecurity and raising taxes, Germany’s structural reforms may delay or derail the cyclical recovery. Conversely, a timely cut in interest rates might lift the mood, buoy Mr Schröder’s fortunes and sweeten the pill of structural reforms. If they are to stay on course, Mr Schröder’s reforms need a fair wind. And the ECB can provide it.
The ECB, of course, shouldn’t cut rates just because politicians ask it to. But neither should it not cut rates because they ask it to. The danger is that, in its eagerness to appear immune to the political flak, the bank ignores a clear warning shot from the economy.
economist.com |
