Bill Emmott - International Author & Adviser


ECB - No Interest Cuts For Now
Corriere della Sera - January 28th 2008

For central bankers these days, it is a matter of pride to be able to stand up and ignore pressure from two sorts of directions: pressure from politicians, who are by definition reckless, and pressure from stockmarkets, who are by definition over-emotional. That is why Jean-Claude Trichet, the president of the European Central Bank, has this week been so determined to say that the ECB is not going to follow the Federal Reserve in America by making a panicky cut in interest rates. Mr Trichet is right to guard his independence and to emphasise the ECB’s concerns about inflation. But he must not keep on doing so for too long. By the time spring is turning into summer, the ECB should be cutting its interest rates.

             The basic statistics support Mr Trichet’s position. America may be heading for a recession but in the euro area economic growth is still proceeding steadily. Consumer price inflation, however, is 3.1%, compared with the ECB’s official target for inflation of “below but close” to 2%. Wage negotiations are under way, especially in the Europe’s most important economy, Germany, and the ECB does not want to encourage those wage deals to be inflationary.

            That is fair enough. But all these statistics refer to the past, not the future. The dramatic interest rate cut by the Fed suggests that it believes that the future is going to be tougher and much less inflationary in America than the recent past: in America, there has only been one month of rising unemployment and inflation remains officially at 4%, but the Fed seems to think that consumer spending is dropping sharply, that more losses in banks and insurance companies are on the way, and that deflation is as much of a danger as inflation.

            If that prediction by the Fed is right, then Europe’s economies will also be affected quite quickly. Exports to America are already being hurt, and they will drop more sharply in future. But the most important effects for the ECB should be the impact on the euro and on oil prices, for they have a direct influence over inflation. The continued rise of the euro against the dollar produces an automatic tightening of monetary conditions in Europe, as well as reducing the prices of imported goods, including the most inflationary items recently, namely oil and food. At the same time, oil prices have begun to fall in dollar terms—they are now 10% below their November peak—as fears grow of a recession in the world’s biggest market for oil, namely America.

            No one can foresee the future accurately. Central banks have the difficult job of trying to manipulate people’s expectations about the future, by which is meant expectations of future inflation, while at the same time trying to anticipate the future of real economic activity themselves. It takes many months before a cut or an increase in interest rates has an effect on companies and consumers, so central banks do have to attempt to foresee what is going to happen.

            The European Central Bank may be right to talk tough now. It can carry on talking tough until Germany’s wage negotiations are completed. But at that point, it is going to have to accept the reality of a slowing European economy. It will then be time for it to begin cutting European interest rates.


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