U.S. interest rate cut surprises Europe

By Batuk Gathani

BRUSSELS, JAN. 4.The timing of the U.S. Federal Reserve's decision to cut interest rates by half a per cent ostensibly to halt slide in the economy has surprised the European financial community.

This morning, the European and U.S. stocks rallied sharply on both sides of the Atlantic and for investors this is a long awaited respite from relentless selling of shares in recent days. The debate in the European financial circles now is whether the European Central Bank will follow the lead of the Federal Reserve and lower the interest rates to boost the prospects of a healthy economic growth in the 12 euro-zone countries.

Analysts also took note of a submission by the Berlin based key European economic-research institute - D.I.W. - which warns that the Central Bank's tight monetary policy may `chock off' economic growth in Germany, the euro-zone's largest economy and the world's third largest economy after the U.S. and Japan.

According to the D.I.W., economic growth in the euro- zone region may not exceed two and half per cent this year though government's official forecast indicates 2.75 per cent growth. The rise of inflation in the euro-zone region is blamed on foreign economic factors like the sudden oil price rise and the significant decline of the euro.

Now that the oil prices have receded from the 10 year highs set in the last quarter of 2000 and coupled with euro's healthy recovery against the U.S. dollar and other leading currencies, it is argued that this is a classic opportunity for the Bank to follow a pragmatic and imaginative interest rate policy. The Bank faces a difficult challenge as economic growth and inflation rates in different euro-zone countries are not consistent.

The institute today blamed the Bank's ``too restrictive monetary policy'' for the modest economic growth in Germany and other euro-zone countries. The D.I.W. report states that inflationary pressures in the euro-zone countries are diminishing with the decline of oil prices and stabilisation of the euro.

This prompts financial observers to suggest that the Bank can also follow the example of the U.S. Federal Reserve and initiate a modest cut in euro-zone interest rates. The unemployment in the region is also falling and the DIW estimates that unemployment will fall to 8.5 per cent mark this year and perhaps eight per cent next year.

This is good news for politicians who face prospects of general elections in Britain this year and in Germany and France next year. Germany is embarking on a bold programme of tax reforms and cuts which may further boost prospects of a healthy growth. The D.I.W. predicts good chances of an economic `soft landing' in the U.S. but warns that all forecasts are on the `down side'.

With an appeal for high economic growth, the institute's chief economist, Mr. Gustav-Adolf Horn, calls on the Bank to ease its benchmark interest rate, now at 4.75 per cent. Speculation in the market would suggest a drop of a quarter per cent.

The Bank funds interest rate is essentially a floor for credit markets, and defines interest charged on short-term loans among creditworthy borrowers. Any change in its interest rate policy could add or drain cash from the national economy.

For example, interest rate reduction helps to make it easier for borrowers to service their debts or buy productive capital assets like factory machinery etc which helps to improve productivity and boost national economy.

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Section  : International
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