Europe keeps interest rates steady

/ Source: news services

The European Central Bank held interest rates steady as expected on Thursday for the 17th month in a row, uncertain about how resilient the euro zone economy will prove to a strong currency and high oil prices.

Separately, the Bank of England also left its key interest rate unchanged at 4.75 percent.
It was the third month in a row that the bank’s Monetary Policy Committee has left the rate unchanged. The decision was widely expected following indications that Britain’s economy has slowed.

The decision by the ECB buys the central bank more time to gauge whether the 55 percent surge in crude oil prices this year is driving up underlying inflation or whether euro zone recovery is running into strong headwinds that should hold inflation in check.

For the 12-nation euro zone, rates this low are extremely stimulative. The economy is expanding at roughly a 2 percent annual rate with inflation at 2.5 percent in October, which means that short-term money is basically free.

Given so much cheap cash, analysts said they will listen closely for any heightened ECB concern over inflationary risks. But the ECB's rhetoric last month of "strong vigilance" may moderate somewhat in the face of euro strength, since this offsets some of the inflation pain for imported goods, notably oil.

But there is a flip side. Deutsche Bank calculates that if the euro's 3 percent rise over the past few months is sustained, it will damage exports enough to shave 0.5 percent off euro zone growth in the coming year, throwing doubts over the robustness of the recovery.

That would be unwelcome for an economy that remains too weak to reduce 9 percent unemployment or revive lacklustre consumer spending. In the euro zone's largest economy, Germany, joblessness rose to a six-year high last month and a weak manufacturing report in October showed the labour market outlook was worsening.

So far ECB policymakers have sounded no alarms on the euro.

Executive Board member Jose Manual Gonzalez-Paramo said he was "not at all" concerned and the Bundesbank's Axel Weber said the euro, which was trading on Thursday at 8-1/2 month highs at $1.2858 -- within one cent of its record high -- "has only been a minor effect".

Analysts say the monetary tightening effects of euro strength give another reason for the ECB to delay a rate hike.

"The inflation benefits of the euro rise and caution on the growth outlook in the face of the headwinds should see the ECB holding off from tightening rates until the second half of 2005," said Mark Wall, Deutsche's senior European economist.

Euribor futures likewise do not fully factor in an ECB rate hike until the third quarter of 2005. A Reuters poll last week also showed market analysts are starting to push back the timing of a rate hike toward mid year.

As long as no second-round inflationary effects show through -- where high oil prices and masses of cheap money feed into broader price pressures -- analysts see the ECB in no rush to raise rates until growth is on firmer ground.

German industrial orders fell unexpectedly in September by 0.2 percent from the previous month on weak domestic demand. But a wage freeze until 2007 at Volkswagen was further evidence that the medium-term inflation prospects look benign.