European Central Bank hints at April interest rate drop

Interest rates may fall as soon as next month, the European Central Bank (ECB) has hinted in its latest monthly report.

Rising food prices because of the foot-and-mouth scare and increases in the costs of services mean the ECB cannot cut rates much earlier as inflation is likely to remain above 2 per cent.

The tone of the March monthly report is the most positive the ECB has been in recent times in relation to rate cuts. However, like all central banks, it never makes its intentions completely clear until shortly before any interest rate movement.

According to Mr Colin Hunt, head of strategy at Goodbody Stockbrokers, the ECB will cut rates towards the end of April. "This report is notably less hawkish. They talk about oil prices and the euro but that is more lining up excuses about why they will cut when inflation may remain above the 2 per cent target rate. "

Hinting at rate cuts, the ECB points to declining rates of growth in money supply and notes that the "risks to price stability stemming from the monetary side have become more balanced over recent months".

The Bank is also slightly less positive about economic growth and a little more concerned about the possible impact of the US slowdown. A fall-off in economic growth, while not directly considered by the ECB in deciding interest rate levels, would put downward pressure on prices and make the Bank more likely to cut interest rates.

Overall it considers that eurozone growth will "remain fairly robust". However, it does note that there is a potential that weak growth in the US could spill over to Europe, although as yet there is no sign that it will do so. "Nevertheless, a close monitoring of global developments is warranted."

Growth figures released yesterday appeared to confirm this. Euro-zone growth rose 0.7 per cent in the last three months of 2000 to 3 per cent. This compares with a revised growth figure of 0.5 per cent to 3.2 per cent in the three months beforehand. This was just slightly below market expectations for growth of 3.1 per cent.

But the real problem is inflation. Euro-zone inflation fell to 2.4 per cent in January from 2.6 per cent in December, mostly due to declining oil prices.

More worryingly for the ECB, inflation - excluding energy - rose to 1.9 per cent from 1.7 per cent in December. That is perilously close to the ECB's target top rate of 2 per cent. This was mostly due to price rises in services and unprocessed foods.

The report also warned that the indirect effects of past oil price increases and the depreciation of the euro were still coming through. "These factors might prevent consumer price inflation from falling below 2 per cent for some months to come."

Mr Austin Hughes, chief economist at IIB Bank, pointed out that the Bundesbank council member Mr Klaus-Dieter Kuehbacher hinted this week that Europe might have to play a role in promoting world growth, particularly if the situation in Japan or the US gets any worse. He also said rates would not be cut until inflation hit 2.2 per cent.

"The likelihood now is that there will be a half point rate cut in May," Mr Hughes said. "But if the US or Japan weaken markedly there is an outside chance it could be April."