European Bank Leaves Rate Unchanged

Associated Press
08.05.2004

The European Central Bank left its key interest rate untouched Thursday at 2 percent while it waits for confirmation that an economic recovery is solidly under way.

The decision by the bank's 18-member governing council, meeting by teleconference due to the summer vacation season, was widely expected by economists.

Faced with a nascent but uncertain economic upswing, the bank has hunkered down with "no bias" toward moving rates up or down, as bank President Jean-Claude Trichet has put it several times, instead remaining "vigilant" for signs of trouble - either faltering growth or increasing inflation.

Economists have interpreted his remarks to mean the bank will keep rates steady for another few months and then to start raising it to ward off inflation, which can be a side effect of growth. The 12 countries that use the euro are emerging from slow 0.8 percent growth in 2003, with growth of 1.3 percent in the first quarter over the year-ago period.

The pickup has lagged behind more robust expansions in the United States, Japan, and China, with worrisome signs such as mixed surveys of business confidence in sluggish Germany, the euro zone's biggest economy, and a rise in the German unemployment rate to 10.5 percent in July from 10.2 percent the previous month. While European exports into the growing world economy are rising, consumer demand remains shaky.

"We assume that in the early part of next year at the earliest there will be a moderate interest rate increase, and that is what the market expects," said economist Dorothea Huttanus at DZ Bank in Frankfurt. "The little bit of a recovery that we see is not yet on a broad basis."

Bank officials, who did not explain Thursday's decision, have remained cautious because a premature rate increase could choke off the recovery by raising borrowing costs for businesses. Yet if they wait too long, they could see inflation already well established by the time they start raising rates.

The ECB faces a far different situation than the Bank of England, which raised its key rate Thursday by a quarter-point to 4.75 percent - its fifth increase in 10 months - to try to cub the inflationary effects of rising housing prices and strong consumer spending.

The U.S. Federal Reserve has also begun slowly raising rates as the U.S. economy hits its stride.

In Britain "internal demand is instead too strong, and the bank must use every available means to keep the economy from overheating," Huttanus said.

By not adopting the euro, Britain has kept its own independent interest-rate policy, while the ECB must find one set of rates to fit all the countries for which it decides monetary policy.

For now, inflation is not considered a looming problem in Europe despite high oil prices that pushed up annual inflation to 2.4 percent in July, according to preliminary data by the European Union's statistics agency. That is above the ECB's guideline of lower than, but close to 2 percent, but Trichet has said he thinks prices will ease next year.

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