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Business

Euro Zone Interest Rates Signal Uncertainty

The eurozone's sluggish economy may force the European Central Bank to keep interest rates steady and could render even more uncertain the direction of its monetary policy.

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The single currency is facing uncertain times ahead

Worrying signs surfaced this past week in the 12-nation eurozone -- an erosion in confidence on the part of businesses and consumers, high unemployment in France and Germany, declines in manufacturing activity.

After slowing growth in the second half of 2004, the recent indicators raised fears that the economic slump was not passing as quickly as hoped.

Officially, ECB policymakers, who will meet next Thursday and are expected to keep their benchmark interest rate at two percent, remain confident. "I am cautiously optimistic and maintain that the economic recovery will take hold during 2005," said Lucas Papademos, the ECB vice-president, in an interview this week.

But that message seems to be more and more out of sync with reality. The bank that sets monetary policy for the countries sharing the euro has in fact been somewhat embarrassed. The ECB had begun to prepare financial markets for its first interest-rate increase since June 2003, most likely in the fourth quarter of this year.

Real risk of inflation spurt

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The ECB policymakers had pointed to the low cost of credit that was creating an excess of liquidity, and in particular the strong real estate market in several countries that risked provoking a spurt in inflation. But weak economic growth in the eurozone threatens to defer that scenario.

The anticipated increase in rates had been "reinforced by certain statements by the ECB about the inevitability of rates going up again and also after the revision" of the European Stability and Growth Pact, said Patrick Artus, director of economic research at CDC Ixis in a study published Friday. "We think however that the economic outlook for the eurozone makes a rate increase with the next year or more extremely unlikely," Artus said.

The ECB was on the verge of raising rates late last year, a high-level source close to the central bank told AFP. But policymakers changed their minds because of soaring crude oil prices and the euro's appreciation against the dollar.

Credibility of single currency at risk

Euro Münzen

For ECB watchers, the guardians of the euro are also playing with their credibility. "By crying wolf, they may end up not being believed," warned Eric Chaney, an economist at Morgan Stanley. "I do not find it very easy to interpret the ECB," he said.

Critics point out by comparison that the US Federal Reserve, the central bank of the world's biggest economy, seeks to communicate with absolute clarity. Last year the Fed clearly prepared the markets one month before it began to raise interest rates, taking a measured approach to a tougher monetary policy.

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