[A-List] UK eurozone membership

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

Bank is model for 'new' ECB

Faisal Islam, economics correspondent
Sunday November 10, 2002
The Observer

The path towards Britain's possible entry into the euro will be made much
easier by a radical French plan for the European Central Bank to be reformed
in the image of the Bank of England.
French Prime Minister Jean Pierre Raffarin's Council of Economic Advisers
recommends that the ECB adopts three major reforms to its monetary policy
arrangements. If adopted, they would allay most of Gordon Brown's concerns
about the institutional structure of the Frankfurt-based bank, and make his
'five tests' far easier to pass.

The council's study, by economists Charles Wyplosz and Patrick Artus, was
received warmly by the French PM. The reforms would replace the ECB's
confusing 'two-pillar' target with an inflation target of between 1 and 4
per cent, entirely consistent with the Britain's target of 2.5 per cent.

It argues that an enlarged eurozone should abandon its unwieldy 18-member
decision-making committee, in favour of an executive committee of
economists, like the Bank of England's Monetary Policy Committee.

France's position is important. It is almost certain that ECB President Wim
Duisenberg will be replaced by a Frenchman in July. The favourite, Banque de
France Governor Jean-Claude Trichet, is politically close to Raffarin.

-----

Doing the Continental

The Bank of England and the European Central Bank now act as one on rate
setting

Faisal Islam
Sunday November 10, 2002
The Observer

The Atlantic divide is growing. The continents are not just pulling apart
physically and politically, but also in their approach to monetary policy.
Federal Reserve Chairman Alan Greenspan threw down the gauntlet last
Wednesday with a 'double' 0.5 per cent cut in the Federal Funds rate. But
both European banks shunned his lead.
The European Central Bank's declaration of independence is particularly
relevant for its president Wim Duisenberg. In his previous job as central
bank chief in the Netherlands, he earned the nickname of 'Mr 10 seconds' for
the time that he took to mimic the decisions of the Bundesbank. But the
really important point is that the Bank of England seems to be mucking in
with its European neighbours.

Much is made of the institutional inadequacy of the ECB compared with the
good burghers of the Bank of England's Monetary Policy Committee. Where the
Bank has vaults of gold and secret tunnels in its basement, the ECB has got
a bar-cum-nightclub.

In fact, the ECB and the Bank of England have been speaking with one voice
for most of the past year. Both have made exactly the same decision in
respect of base interest rates in each of the 13 meetings over the past 12
months. For two years monetary policy has been almost indistinguishable,
with 21 rate-setting meetings yielding exactly the same decision.
Significantly, since May last year, when the ECB instituted quiet changes to
its communications policies, 17 of the 19 meetings have had the same result.

The only exceptions were the two meetings immediately after the 11 September
2001 attacks on New York. Then the ECB cut 0.5 per cent at an emergency
meeting in October. The Bank of England cut 0.25 per cent at each meeting -
the same decision, spread over two months. Strip out that and Frankfurt and
Threadneedle Street have been running the same policy for a year and a half.

The banks have not just been singing in tune. Their tone, pitch and rhythm
have been identical. The British economy would be indifferent to whether
monetary policy had been run from London or Frankfurt.

'It does suggest that the economic shocks and the response to those shocks
felt in Britain and the eurozone have been the same,' says Martin Weale of
the National Institute of Economic and Social Research.

However, domestic demand conditions have been different. Overall economic
growth has been slower in the eurozone this year than in Britain. Growth was
higher in the eurozone in 2000, and roughly equivalent last year. The
weakness of the German economy is cited as evidence for ECB inertia.

Taking a decision solely on the basis of the ill health of the German
banking sector makes as much sense as the Bank of England cutting rates on
the basis of an embattled regional building society.

Besides, ECB rates, at 3.25 per cent - 0.75 per cent lower than the Bank of
England's - can hardly be described as punitively high.

The ECB sceptics point to the fact that US base rates are now two whole
percentage points below euro rates.

The balance sheets of most European banks are directly affected by the
central bank discount rate. One of the reasons for the weak profitability of
the German banking sector is that very low interest rates in the US are
allowing American banks to borrow and then repurchase government bonds,
helping to offset losses on company bankruptcies. So why doesn't Frankfurt
follow suit?

The Federal Reserve gave Wall Street clear signals that it was going to cut.
This strategy only works if the person making monetary policy decisions -
Alan Greenspan - has the absolute faith of markets, and the institution has
total credibility. In effect it is 'spending credibility' earned over
decades.

Interrogate any ECB member about transparency, and they say that the bank is
young and needs time to earn credibility with the financial markets. To cut
now, while inflation is above its 2 per cent cap, and with uncertainty over
euro countries' budget deficits, would alleviate short-term pain, but add to
uncertainty about the indefinite future.

The ECB did not cut rates this week for much the same reason as the Bank of
England - that weakness in manufacturing industries of the north did not
balance off a still exuberant southern flank.

The Bank of England had more scope to cut rates, as inflation is comfortably
below the 2.5 per cent target. It, too, might be holding off due to the
inflationary impact of extra public spending. Or per haps Frankfurt's
decisions are having a more direct effect on the Bank of England and
Britain's possible adoption of the euro. The correlation of eurozone and
British monetary policy certainly offers strong foundations for any push on
entry.

European monetary policy has become incrementally anglicised in recent
months. Last year the ECB shifted its meetings to a monthly basis, as with
the Bank of England. Just last week, Duisenberg, for the first time, hinted
at the extent of discussion within the ECB governing council about a rate
cut. A French plan, published last week, suggests that the ECB adopt a
target range for inflation of 1 to 4 per cent, consistent with the Bank of
England's point target of 2.5 per cent, and an MPC-style executive
committee.

The banks appear to be courting. A spring engagement is still not out of the
question.