ECB strongly signals further interest rate cut

The European Central Bank (ECB) has given a strong indication that it will cut interest rates again soon, publishing forecasts showing that its economists expect inflation to drop well below its objective of "close to" 2 per cent.

The ECB's latest twice-yearly projections on the outlook for the euro-zone's economy, published in its monthly bulletin, also slashed its growth forecasts for both this year and next.

Mr Wim Duisenberg, the bank's president, and other senior officials have in the past few days been refusing to pre-empt future rate decisions. Mr Duisenberg said yesterday it was "too early" to discuss further cuts.

But the ECB's forecast that inflation is expected to be around 1.3 per cent next year, and probably falling, suggests that the pressure for a cut in the next couple of months will be difficult to resist.

The ECB's strategy review, published last month, committed the bank to keeping inflation below but "close to" 2 per cent. A fall to 1.3 per cent would count as failing to meet that objective.

The ECB's forecasts are projections made by its staff with help from economists at the eurozone's national central banks, rather than a direct reflection of the views of its rate-setting governing council. But they have come to have a growing influence over policy decisions.

A leak of the inflation projection had appeared in news reports on Wednesday, provoking outrage from analysts at the ECB's failure to keep market-sensitive information secure.

The ECB said the rise of the euro, up 15 per cent on its 2002 average value against a trade-weighted basket of currencies, was a key reason for revising down its expectations for growth and inflation. It also cited weaker global demand.

The mid-points of the forecast ranges, published in the ECB's June monthly bulletin, put growth at just 0.7 per cent this year, against December's estimate of 1.6 per cent.

Growth is expected to pick up only to a mid-point of 1.6 per cent, well below the euro-zone's long-term trend growth rate of 2-2.5 per cent. With continued below-trend growth, the euro-zone's output gap - the difference between actual and potential output is likely to grow, and inflation is likely to fall even further.

Economists warned the updated projections could still prove too optimistic, and that deflation in the euro zone was a realistic possibility for 2005.

"With inflation defeated, the real enemies are now low growth and low inflation, if not deflation," said Mr Luigi Buttiglione of Barclays Capital.

The ECB cut key rates by 0.5 of a percentage point to a record low of 2 per cent last week.

Giving evidence to the European Parliament's monetary policy committee yesterday, Mr Duisenberg urged governments to reduce pension costs and unemployment instead of calling for further interest rate cuts.

"Monetary policy cannot by itself solve the problems underlying the weak growth and employment performance in the euro area," he said.

ECB council member Mr Ernst Welteke said yesterday there was more room for manoeuvre in economic policy than in monetary or budget policy. "There is room for manoeuvre in politics, not so much in monetary and fiscal policy," he said in reply to a journalist's question on whether the ECB had used up its monetary leeway with last week's cut.

Mr Welteke, speaking to reporters on the margins of an economic forum, said economic policy makers must push ahead with social systems reforms in order to rebuild public confidence. "Monetary indicators show that the economy has sufficient liquidity to finance higher, inflation-free growth," he added. - (Financial Times Service/Reuters)