[A-List] Global economy: ECB intransigence

["Michael Keaney" <michael.keaney@xxxxxx>]

Europe missed a chance to pull us back from the brink

Alf Young says Wim Duisenberg and his European bank colleagues have once
again failed to take the necessary action to stimulate economic activity
The Sunday Herald, 10 November 2002

SHOCK, horror. McDonald's, that capstone of corporate America and yellow
arch symbol of US economic power around the globe, issued a profits warning
on Friday and said it would close around 175 outlets worldwide and slash 600
jobs.

This isn't the first dose of strong medicine dished out in Ronald McDonald's
fast-food empire to address flagging sales at home and the impact of BSE on
the number of Big Macs flipped in Europe and Japan. This is, in fact,
McDonald's third major lay-off programme in five years.

Despite estimated 3.1% US growth in the third quarter, corporate America is
still hurting bad, caught up in a dangerous cocktail of weakening consumer
confidence, the fallout from assorted boardroom scandals and uncertainty
about whether the world's last superpower may soon find itself at war with
Iraq.

Most of the economic signals for the current quarter are pointing
depressingly south. One of the few bright spots has been Wall Street, with
the Dow posting a 20% gain over the past four weeks.

Not surprising then that the US Federal Reserve cut interest rates again on
Wednesday, the first reduction since December 11 last year. The surprise is
the cut is a full fifty basis points, taking the short-term cost of
borrowing to 1.25%. Given where US prices have been or are likely to be in
the months ahead, that means the real baseline cost of borrowing money in
America is now negative -- an invitation to the fainthearted to fill their
boots and start investing and spending again.

Alan Greenspan and his colleagues describe the current economic climate
across the Atlantic as a 'soft spot'. So to toughen resolve and get US
consumption, production and employment back on a more predictable track,
they have gone for broke. When rates get this low, as Lex put it in the FT
on Friday, the Fed now has only dimes left to throw at a recovery.

The size of the stimulus hasn't gone down well in the markets. On Thursday
the Dow was off by 2.1% and off by about half as much again on Friday.
That's still a modest correction against a 20% rally in the previous four
weeks. However, suspicions were growing that the size of the rate cut was
proportionate to the scale of the private fears the Fed harbours about the
prospects for US recovery.

On Thursday, neither our own Monetary Policy Committee nor the European
Central Bank saw fit to follow the Fed's lead. Rates stayed on hold at 4%
and 3.25% respectively. Neither decision is likely to have been unanimous.
The MPC was split 6-3 in October about the wisdom of a cut. The ECB outcome
was accompanied by coded hints of a row.

The gap between interest rates in the US and Europe -- including the UK --
is now substantial. The currency markets responded accordingly. The dollar
weakened against sterling, the euro and the yen. The pound is now testing
two-and-a-half-year highs against the greenback.

That's not encouraging news for our exporters trying to sell into the US or
other dollar denominated areas. And with ECB doing nothing to stimulate
flagging growth across the eurozone, the consequential lack of demand can't
be making life any easier for companies here trying to export to the
continent.

Potentially more grim news, then, for what's left of a manufacturing sector
which, as far as Scotland is concerned, has been in recession ever since the
dawn of the new millennium.

Our own MPC's reluctance to act on rates is more understandable than the
ECB's. With only one rather crude lever at its disposal, the Bank of England
committee has to weigh any further fiscal loosening against the impact even
cheaper money might have on an already red-hot residential property market.

The MPC's reasons to be fearful about stimulating a property crash were
underlined on Friday when the latest house price index from the Halifax put
annual inflation in UK housing at an astonishing 30.6% in October, not that
far off the 34.4% peak reached before the last house price bubble burst in
the late 1980s.

I know, I know. It isn't a bubble this time. Mortgage repayments today
represent only 15% of gross earnings for the typical first-time buyer, the
lowest ratio since 1984. And that Halifax house inflation rate of 30% plus
is distorted by weak demand in the immediate aftermath of September 11.
There's also the rival Nationwide survey that shows prices going more
slowly, by only 24% year-on-year in October.

However, for all the caveats, the perception of house prices rising so
relentlessly that a bubble is all but inevitable persists. At one level the
government will be cheered by all the extra stamp duty on housing
transactions it is raking in and by the growing inheritance tax take when
properties worth more than £250,000 -- now roughly the average price of
housing in London -- are passed on in a tax-inefficient way to offspring. At
another level, ministers must fear the political fall-out of another housing
bubble bursting nearer to the next election.

That leaves the ECB, still more preoccupied with keeping eurozone inflation
in check than with stimulating economies like Germany's which could be
heading for a protracted period of stagnation. Ask, as I did this week, a
convinced advocate of joining the euro, like Kenneth Clarke, what he thinks
of the ECB's present fiscal stance and he'll tell you he regards it as
looser than either the UK or the US.

But if it is, why are so many of the larger eurozone economies doing so
badly in terms of output and employment? On Thursday, Wim Duisenberg tried
to deflect attention towards what individual EU member states should be
doing to accelerate structural reform within their own labour and product
markets and to keep their budget deficits under control.

But structural reform is a long-term game. The medium-term outlook for
inflation across the zone is benign. The ECB missed a real opportunity on
Thursday to inject a fiscal stimulus of its own and get continental Europe
growing again. We may all suffer the consequences of its again sitting on
its hands.