msnbc.com news services
updated 3/4/2004 8:42:22 AM ET 2004-03-04T13:42:22

The European Central Bank ignored politicians’ pleas for an interest rate cut Thursday, leaving its key refinancing rate unchanged as it waits for an expected recovery to take hold.

The widely expected decision at a meeting of the bank’s 18-member governing council left the rate, which sets short-term central bank rates to commercial banks, at 2 percent — its level since a half-point cut last June.

Fears about the effect of a stronger euro on Europe’s budding recovery have led to political pressure for lower rates, which could dampen the euro’s rise and give the economy a quick boost. German Chancellor Gerhard Schroeder last week urged the bank to “think over interest rate reactions” to the stronger currency, and his remarks were seconded by French Prime Minister Jean-Pierre Raffarin.

The euro’s value has risen about 50 percent against the U.S. dollar from its October 2000 low, making European exports more expensive compared to foreign competition.

But the ECB, which is forbidden by its founding treaty from taking instructions from national governments, has shown little inclination to heed politicians’ hints since its launch in 1998. Some observers say such pressure could even backfire by making bank officials dig their heels in to protect their reputation for independence.

All 28 economists surveyed by Dow Jones Newswires had said they expected no rate change Thursday.

Bank president Jean-Claude Trichet has expressed concern about sharp swings in exchange rates but had dropped no hints that the bank is considering a rate cut. The bank says rates are already low enough to support growth.

Most economists think a moderate recovery is going to happen anyway, leading the bank to raise, not cut, interest rates late this year or early next year to ward off inflation. The euro zone economy grew a sluggish 0.4 percent last year.

Before the rate decision, economist Claudia Henke at Dresdner Bank in Frankfurt said that although some early indicators have come in below expectations, “this is no sign that the global recovery will occur without Europe.”

The euro’s fall this week against the dollar — after several months of sharp increases — also takes some of the pressure off the bank. The euro has fallen some 8 U.S. cents, or 6 percent, over the past 11 weekday trading sessions and changed hands just under $1.22 on Thursday.

Meanwhile, inflation remains below the bank’s guideline of 2 percent, with a 1.6 percent annual increase in February.

Bank of England rates unchanged
The Bank of England also left rates unchanged Thursday, with its key rate at 4 percent. Britain has retained its national currency, the pound, and the right to its own interest-rate policy.

Last month, the Bank of England raised rates by a quarter-point for the second time since November, and economists said more hikes are just a matter of time.

House prices and consumer demand have still shown no sign of slowing as the BoE wants, but few analysts had expected a hike so soon after the last one, given sterling’s strength and uncertainty about the effect rate rises would have on debt-laden consumers.

With every indicator, however, pointing to an economy powering ahead, the risk is rising that borrowing costs will go up by another quarter-point next month or in May as the Bank tries to keep a lid on inflationary pressures further out.

“The only question is when, not if, interest rates will rise. Consumers and business should be aware that further interest rate rises are just around the corner,” said Graeme Leach, chief economist at the Institute of Directors.

Financial markets reacted swiftly to the announcement. Gilt and interest rate futures rose and the pound fell back against the euro and dollar on relief that the central bank had not pulled the rate trigger again.

Futures markets are pricing in rates a full percentage point higher in a year’s time.

Business as usual
Industry groups were delighted with the BoE decision even though most have pencilled in more rate rises ahead. But they want the central bank to go slowly for fear of killing the manufacturing recovery and pushing consumer spending down too far.

“Manufacturers will welcome this breathing space which will allow them to take advantage of an export-led recovery,” said Dougie Peedle, deputy chief economist at the Engineering Employers’ Federation.

The BoE offered no explanation for its decision but minutes of the MPC’s meeting will be published in a fortnight. All nine members voted for last month’s rate hike and there is a good chance some members wanted to raise rates this month even though inflation currently remains well below its 2.0 percent target.

There was probably a lot of discussion on just how the rise in sterling, which hit its highest level in a year against the euro this week, should be treated when it comes to setting policy.

Some members feel that the strength may be just temporary and should be disregarded for the purposes of setting monetary policy unless people and companies start changing their wage and price-setting behaviour as a result.

But others argue that the pound’s rise will dampen growth and inflation and that reduces the need for rate hikes.

The dollar’s dramatic turnaround in the last few days, however, will also have allayed somewhat fears of economic recovery being derailed in the euro zone, Britain’s biggest export market.

(Reuters and the Associated Press contributed to this report.)

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