Stronger euro key factor in ECB decision to hold rates

The European Central Bank (ECB) has left interest rates unchanged, citing a stronger euro as a factor that is keeping inflation in check.But the ECB president, Mr Wim Duisenberg, warned that interest rates could rise from their present level of 3.25 per cent if other factors did not change.

"Overall, the strengthening of the euro exchange rate is a new factor suggesting a potential for lower inflation rates. However, other factors - in particular monetary developments and wage trends - do not indicate a moderation in price pressures.

"Monetary policy therefore needs to remain vigilant as regards the key factors determining the outlook for price stability over the medium term," he said.

Mr Duisenberg was speaking after a meeting of the ECB's governing council in Luxembourg, one of two meetings held each year outside its Frankfurt headquarters. The Bank of England also left its interest rates unchanged yesterday at 4 per cent.

Financial markets reacted calmly to the ECB decision, which analysts had expected following the euro's recent rise against the dollar.

A strong euro dampens inflation by making imports, particularly of oil, less expensive. But it can also damage economic growth by making exports less competitive.

Mr Duisenberg said the ECB's decision to hold rates steady was not a response to the turbulence on the equity markets that has seen share prices plunge in recent days. But he acknowledged that the strength of the economic recovery in the euro zone remained uncertain.

"Our conclusion was that while the risks to price stability over the medium term remain tilted to the upside, recent evidence sends mixed signals.

"In view of recent financial developments, the uncertainty surrounding the strength of the economic upturn - both inside and outside the euro area - has not diminished over recent weeks," he said.

Mr Duisenberg sounded more relaxed on the threat to price stability than during recent months, when he had hinted that an interest rate rise was not far off.

Referring to the fall in oil prices and the rise of the euro exchange rate, he said there was no reason to "sound the alarm" if these trends continued.

Mr Duisenberg warned of "worrying fiscal trends" in recent months, a reference to promises by the new French government to cut taxes and increase public spending.

"We call upon all member countries to honour the commitments made to achieve budgets that are close to balance or in surplus by 2003-04, in compliance with the framework of the Stability and Growth Pact.

"This is necessary in order to maintain and further strengthen confidence in the policy framework of the euro area and to establish fiscal positions in all countries that allow automatic stabilisers to operate efficiently without endangering sound fiscal positions in the longer term," he said.