Brighter business prospects in Europe as global recovery builds and the euro weakens have pushed prospects of an interest rate cut when the European Central Bank meets on Thursday firmly into the background. Two euro-zone monetary officials told that most central bankers on the ECB's rate-setting Governing Council see little benefit in lowering interest rates right now. The vast majority of ECB policy makers thinks that a quarter percentage point rate cut would have a negligible impact in fostering more growth, given the long lag before an easing helps economic activity, said one senior official at a euro zone central bank. "That would be a drop in the bucket," he said. "It would not do anything, and I think most of the members share this view." Additionally the euro's retreat -- down almost four percent on a trade-weighted basis from its January peak and over six percent against the dollar -- is boosting export orders and providing a much-needed lift. "Given the relative strength of the euro, I don't see any reason why they would change interest rates," said another euro zone monetary official. "With the euro at $1.19 to $1.20, many central bankers would say, 'That is a dream. That is exactly where we would like it,'" he said.
These comments made over the past week ahead of the ECB's rate-setting meeting on Thursday confirm the view of markets and economists that the central bank will hold rates steady in May at 2.00 percent for the 11th straight month. In a poll, 64 out of 66 economists said they expect no change in rates on Thursday while two-thirds say the rate-cutting cycle is over. . Euribor contracts reversed course in April to erase rate-cut expectations by June and now are fully pricing in a monetary tightening by year-end <0#FEI:>.
FREE MONEY
ECB policymakers certainly have given no hint they are considering a rate cut. "We have a financial environment of appropriate market interest rates that are conducive to growth and job creation," ECB President Jean-Claude Trichet said last Thursday. "The available information still points to a slow, moderate recovery. We are keeping a watchful eye on the situation," said ECB Vice President Lucas Papademos a day later. Indeed manufacturing surveys released on Monday supported this gradual recovery view, as the euro zone Purchasing Managers Index rose to its highest rate in over three years in April. A softening euro certainly has helped. New export orders are picking up, notably in the euro zone's three biggest economies Germany, France and Italy. Moreover, the currency's decline from its February peak above $1.29 to territory last seen in November 2003 has delivered the equivalent of about 0.40 percentage point in monetary easing, which is improving business confidence. "What was so worrying for business was that the euro was heading up in a straight line. That's not happening now," said Klaus Baader, economist at Lehman Brothers in London. Yet past euro appreciation has left the euro zone with a bad hangover. It crimped business growth in the first quarter, delaying the rebound in domestic consumption and thus slowing overall recovery, he said.
OIL SLICK
Add on top of that rising oil costs, up effectively 20 percent in April alone, and growth prospects are far from rosy. Higher oil prices will hit consumer purchasing power. "We are looking at half a percentage point loss in real disposable income. It is an important factor," said Baader, who expects the ECB to stay on hold well into 2005. Indeed, the International Energy Agency on Monday estimated that oil at $35 a barrel would shave 0.5 percent off euro-zone Gross Domestic Product this year -- an unwelcome prospect for the ECB which forecasts about 1.6 percent growth this year. Against this backdrop, Deutsche Bank economist Thomas Mayer is perplexed that ECB policymakers see no virtue in cutting rates. The ECB's own research shows that a one percentage point rate cut would lift GDP by 0.3 percent in the first year and by 0.8 percent in the third year. Half of the impact comes through consumption starting in the first year, Mayer said. "Over time it accumulates, and if you say rate cuts have no effect, then you are coming dangerously close to saying we can abolish the ECB because it cannot affect output and therefore it cannot affect prices. "This is a self-defeating argument," he said.///