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ECB Should Cut Rates to Boost Growth, Tame Euro: Matthew Lynn

Jan. 9 (Bloomberg) -- The Federal Reserve has lowered interest rates in response to the credit crunch. So has the Bank of England. So far, however, the European Central Bank has refused to join the rate-cutting party.

As 2008 unfolds, that will change. The ECB will have to deliver lower borrowing costs. There are already signs that the economy is weakening across the euro area, and those are only likely to intensify. The property-price declines in Spain and Ireland may soon cause real pain. And the rapid increase in the value of the euro will hit Europe's exporters hard.

``Given the hawkish tone of the December press conference and the clear tightening bias the ECB maintains at the moment, in the early part of the year the risk scenario is that of an additional rate hike,'' Elga Bartsch, a Morgan Stanley economist in London, said in a note to investors. ``In the course of the year, the risk scenario flip-flops to that of a rate cut.''

Right now, all the signals suggest that rate cuts aren't anywhere on the ECB's radar. Only last weekend, ECB President Jean-Claude Trichet was putting out all the familiar messages. ``The ECB's Governing Council stands ready to counter upside risks to price stability, in line with its mandate,'' he told an audience in Germany on Jan. 5.

That isn't to say that the ECB has been ignoring the credit squeeze. Far from it. It has been adding liquidity to the monetary system. It has worked with other central banks to make sure that loans are available. If Europe's banks need to borrow money, they can. But while the Fed and the Bank of England have taken the view that a banking crisis is turning into a more general economic slowdown, the ECB isn't yet convinced. It is offering liquidity to banks, but not rate cuts to hard-pressed businesses or consumers. The current benchmark rate is 4 percent.

Stubborn Inflation

In fairness, Trichet has a point. Inflation remains stubbornly high across the euro area. At 3.1 percent in December, it was above the ECB's mandated target of 2 percent. With oil at around $100 a barrel, consumer prices won't decline anytime soon. It is hard for the bank to reduce rates when its job is to get inflation under control -- and prices are still going up. No one should expect a rate cut this week. There may even be one more rate increase in the pipeline.

Look further out and the story is different. ``By the middle of this year, however, we expect the ECB to have altered its tone dramatically, with interest rates subsequently falling twice to 3.5 percent in the second half,'' London-based consulting firm Capital Economics Ltd. said in a note to investors.

Spot on. As the economic situation worsens, the ECB may well have to modify its views. Here's why.

Weaker Economy

Economic growth in the euro area is weakening. The ECB said in its December forecasts that the growth rate may drop to 2 percent in 2008, compared with 2.6 percent in 2007. With the U.S. and the U.K. economies, two of the main trading partners for the euro area, likely to slow this year, and with bank lending grinding to a halt, even that 2 percent figure may be optimistic.

Next, no one denies that inflation is a problem and it may get worse. Against that, there might soon be significant house- price falls in Europe's most overheated economies. Real-estate values dropped 6.8 percent in Ireland last year, according to real-estate firm Sherry FitzGerald. Lower house prices will feed through into weaker consumer demand and less construction, restraining inflation even if energy costs are still rising.

Third, the rapid increase in the euro's value will hurt Europe's exporters. The euro now fetches $1.47, and with more cuts in U.S. interest rates to come, it might well break the $1.50 barrier soon. If that happens, the squeals of pain will become intense. Toulouse, France-based planemaker Airbus SAS has said the soaring euro may force it to shift some manufacturing out of Europe. Other companies may follow. Yet the only sure way to bring the value of the euro back under control is to cut rates.

Bank Run

ECB council members may also be wondering one thing: What would they do if faced with a run on a lender, as happened when the Bank of England had to bail out Northern Rock Plc? If a Spanish or Irish bank ran into trouble, there is no European government to help it. German taxpayers wouldn't be happy paying for reckless Spanish mortgages. Mightn't it be better to take some inflation risks than to face a bank collapse?

With a slowing economy, falling house prices, a soaring currency, and the threat of a bank failure, the case for rate cuts will only grow. Don't expect any move this week -- or for the next few months. But by mid-2008, the ECB will have joined the global move for lower rates.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net .

Jan. 9 (Bloomberg) -- The Federal Reserve has lowered interest rates in response to the credit crunch. So has the Bank of England. So far, however, the European Central Bank has refused to join the rate-cutting party.

As 2008 unfolds, that will change. The ECB will have to deliver lower borrowing costs. There are already signs that the economy is weakening across the euro area, and those are only likely to intensify. The property-price declines in Spain and Ireland may soon cause real pain. And the rapid increase in the value of the euro will hit Europe's exporters hard.

``Given the hawkish tone of the December press conference and the clear tightening bias the ECB maintains at the moment, in the early part of the year the risk scenario is that of an additional rate hike,'' Elga Bartsch, a Morgan Stanley economist in London, said in a note to investors. ``In the course of the year, the risk scenario flip-flops to that of a rate cut.''

Right now, all the signals suggest that rate cuts aren't anywhere on the ECB's radar. Only last weekend, ECB President Jean-Claude Trichet was putting out all the familiar messages. ``The ECB's Governing Council stands ready to counter upside risks to price stability, in line with its mandate,'' he told an audience in Germany on Jan. 5.

That isn't to say that the ECB has been ignoring the credit squeeze. Far from it. It has been adding liquidity to the monetary system. It has worked with other central banks to make sure that loans are available. If Europe's banks need to borrow money, they can. But while the Fed and the Bank of England have taken the view that a banking crisis is turning into a more general economic slowdown, the ECB isn't yet convinced. It is offering liquidity to banks, but not rate cuts to hard-pressed businesses or consumers. The current benchmark rate is 4 percent.

Stubborn Inflation

In fairness, Trichet has a point. Inflation remains stubbornly high across the euro area. At 3.1 percent in December, it was above the ECB's mandated target of 2 percent. With oil at around $100 a barrel, consumer prices won't decline anytime soon. It is hard for the bank to reduce rates when its job is to get inflation under control -- and prices are still going up. No one should expect a rate cut this week. There may even be one more rate increase in the pipeline.

Look further out and the story is different. ``By the middle of this year, however, we expect the ECB to have altered its tone dramatically, with interest rates subsequently falling twice to 3.5 percent in the second half,'' London-based consulting firm Capital Economics Ltd. said in a note to investors.

Spot on. As the economic situation worsens, the ECB may well have to modify its views. Here's why.

Weaker Economy

Economic growth in the euro area is weakening. The ECB said in its December forecasts that the growth rate may drop to 2 percent in 2008, compared with 2.6 percent in 2007. With the U.S. and the U.K. economies, two of the main trading partners for the euro area, likely to slow this year, and with bank lending grinding to a halt, even that 2 percent figure may be optimistic.

Next, no one denies that inflation is a problem and it may get worse. Against that, there might soon be significant house- price falls in Europe's most overheated economies. Real-estate values dropped 6.8 percent in Ireland last year, according to real-estate firm Sherry FitzGerald. Lower house prices will feed through into weaker consumer demand and less construction, restraining inflation even if energy costs are still rising.

Third, the rapid increase in the euro's value will hurt Europe's exporters. The euro now fetches $1.47, and with more cuts in U.S. interest rates to come, it might well break the $1.50 barrier soon. If that happens, the squeals of pain will become intense. Toulouse, France-based planemaker Airbus SAS has said the soaring euro may force it to shift some manufacturing out of Europe. Other companies may follow. Yet the only sure way to bring the value of the euro back under control is to cut rates.

Bank Run

ECB council members may also be wondering one thing: What would they do if faced with a run on a lender, as happened when the Bank of England had to bail out Northern Rock Plc? If a Spanish or Irish bank ran into trouble, there is no European government to help it. German taxpayers wouldn't be happy paying for reckless Spanish mortgages. Mightn't it be better to take some inflation risks than to face a bank collapse?

With a slowing economy, falling house prices, a soaring currency, and the threat of a bank failure, the case for rate cuts will only grow. Don't expect any move this week -- or for the next few months. But by mid-2008, the ECB will have joined the global move for lower rates.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net .

Jan. 9 (Bloomberg) -- The Federal Reserve has lowered interest rates in response to the credit crunch. So has the Bank of England. So far, however, the European Central Bank has refused to join the rate-cutting party.

As 2008 unfolds, that will change. The ECB will have to deliver lower borrowing costs. There are already signs that the economy is weakening across the euro area, and those are only likely to intensify. The property-price declines in Spain and Ireland may soon cause real pain. And the rapid increase in the value of the euro will hit Europe's exporters hard.

``Given the hawkish tone of the December press conference and the clear tightening bias the ECB maintains at the moment, in the early part of the year the risk scenario is that of an additional rate hike,'' Elga Bartsch, a Morgan Stanley economist in London, said in a note to investors. ``In the course of the year, the risk scenario flip-flops to that of a rate cut.''

Right now, all the signals suggest that rate cuts aren't anywhere on the ECB's radar. Only last weekend, ECB President Jean-Claude Trichet was putting out all the familiar messages. ``The ECB's Governing Council stands ready to counter upside risks to price stability, in line with its mandate,'' he told an audience in Germany on Jan. 5.

That isn't to say that the ECB has been ignoring the credit squeeze. Far from it. It has been adding liquidity to the monetary system. It has worked with other central banks to make sure that loans are available. If Europe's banks need to borrow money, they can. But while the Fed and the Bank of England have taken the view that a banking crisis is turning into a more general economic slowdown, the ECB isn't yet convinced. It is offering liquidity to banks, but not rate cuts to hard-pressed businesses or consumers. The current benchmark rate is 4 percent.

Stubborn Inflation

In fairness, Trichet has a point. Inflation remains stubbornly high across the euro area. At 3.1 percent in December, it was above the ECB's mandated target of 2 percent. With oil at around $100 a barrel, consumer prices won't decline anytime soon. It is hard for the bank to reduce rates when its job is to get inflation under control -- and prices are still going up. No one should expect a rate cut this week. There may even be one more rate increase in the pipeline.

Look further out and the story is different. ``By the middle of this year, however, we expect the ECB to have altered its tone dramatically, with interest rates subsequently falling twice to 3.5 percent in the second half,'' London-based consulting firm Capital Economics Ltd. said in a note to investors.

Spot on. As the economic situation worsens, the ECB may well have to modify its views. Here's why.

Weaker Economy

Economic growth in the euro area is weakening. The ECB said in its December forecasts that the growth rate may drop to 2 percent in 2008, compared with 2.6 percent in 2007. With the U.S. and the U.K. economies, two of the main trading partners for the euro area, likely to slow this year, and with bank lending grinding to a halt, even that 2 percent figure may be optimistic.

Next, no one denies that inflation is a problem and it may get worse. Against that, there might soon be significant house- price falls in Europe's most overheated economies. Real-estate values dropped 6.8 percent in Ireland last year, according to real-estate firm Sherry FitzGerald. Lower house prices will feed through into weaker consumer demand and less construction, restraining inflation even if energy costs are still rising.

Third, the rapid increase in the euro's value will hurt Europe's exporters. The euro now fetches $1.47, and with more cuts in U.S. interest rates to come, it might well break the $1.50 barrier soon. If that happens, the squeals of pain will become intense. Toulouse, France-based planemaker Airbus SAS has said the soaring euro may force it to shift some manufacturing out of Europe. Other companies may follow. Yet the only sure way to bring the value of the euro back under control is to cut rates.

Bank Run

ECB council members may also be wondering one thing: What would they do if faced with a run on a lender, as happened when the Bank of England had to bail out Northern Rock Plc? If a Spanish or Irish bank ran into trouble, there is no European government to help it. German taxpayers wouldn't be happy paying for reckless Spanish mortgages. Mightn't it be better to take some inflation risks than to face a bank collapse?

With a slowing economy, falling house prices, a soaring currency, and the threat of a bank failure, the case for rate cuts will only grow. Don't expect any move this week -- or for the next few months. But by mid-2008, the ECB will have joined the global move for lower rates.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net .

Jan. 9 (Bloomberg) -- The Federal Reserve has lowered interest rates in response to the credit crunch. So has the Bank of England. So far, however, the European Central Bank has refused to join the rate-cutting party.

As 2008 unfolds, that will change. The ECB will have to deliver lower borrowing costs. There are already signs that the economy is weakening across the euro area, and those are only likely to intensify. The property-price declines in Spain and Ireland may soon cause real pain. And the rapid increase in the value of the euro will hit Europe's exporters hard.

``Given the hawkish tone of the December press conference and the clear tightening bias the ECB maintains at the moment, in the early part of the year the risk scenario is that of an additional rate hike,'' Elga Bartsch, a Morgan Stanley economist in London, said in a note to investors. ``In the course of the year, the risk scenario flip-flops to that of a rate cut.''

Right now, all the signals suggest that rate cuts aren't anywhere on the ECB's radar. Only last weekend, ECB President Jean-Claude Trichet was putting out all the familiar messages. ``The ECB's Governing Council stands ready to counter upside risks to price stability, in line with its mandate,'' he told an audience in Germany on Jan. 5.

That isn't to say that the ECB has been ignoring the credit squeeze. Far from it. It has been adding liquidity to the monetary system. It has worked with other central banks to make sure that loans are available. If Europe's banks need to borrow money, they can. But while the Fed and the Bank of England have taken the view that a banking crisis is turning into a more general economic slowdown, the ECB isn't yet convinced. It is offering liquidity to banks, but not rate cuts to hard-pressed businesses or consumers. The current benchmark rate is 4 percent.

Stubborn Inflation

In fairness, Trichet has a point. Inflation remains stubbornly high across the euro area. At 3.1 percent in December, it was above the ECB's mandated target of 2 percent. With oil at around $100 a barrel, consumer prices won't decline anytime soon. It is hard for the bank to reduce rates when its job is to get inflation under control -- and prices are still going up. No one should expect a rate cut this week. There may even be one more rate increase in the pipeline.

Look further out and the story is different. ``By the middle of this year, however, we expect the ECB to have altered its tone dramatically, with interest rates subsequently falling twice to 3.5 percent in the second half,'' London-based consulting firm Capital Economics Ltd. said in a note to investors.

Spot on. As the economic situation worsens, the ECB may well have to modify its views. Here's why.

Weaker Economy

Economic growth in the euro area is weakening. The ECB said in its December forecasts that the growth rate may drop to 2 percent in 2008, compared with 2.6 percent in 2007. With the U.S. and the U.K. economies, two of the main trading partners for the euro area, likely to slow this year, and with bank lending grinding to a halt, even that 2 percent figure may be optimistic.

Next, no one denies that inflation is a problem and it may get worse. Against that, there might soon be significant house- price falls in Europe's most overheated economies. Real-estate values dropped 6.8 percent in Ireland last year, according to real-estate firm Sherry FitzGerald. Lower house prices will feed through into weaker consumer demand and less construction, restraining inflation even if energy costs are still rising.

Third, the rapid increase in the euro's value will hurt Europe's exporters. The euro now fetches $1.47, and with more cuts in U.S. interest rates to come, it might well break the $1.50 barrier soon. If that happens, the squeals of pain will become intense. Toulouse, France-based planemaker Airbus SAS has said the soaring euro may force it to shift some manufacturing out of Europe. Other companies may follow. Yet the only sure way to bring the value of the euro back under control is to cut rates.

Bank Run

ECB council members may also be wondering one thing: What would they do if faced with a run on a lender, as happened when the Bank of England had to bail out Northern Rock Plc? If a Spanish or Irish bank ran into trouble, there is no European government to help it. German taxpayers wouldn't be happy paying for reckless Spanish mortgages. Mightn't it be better to take some inflation risks than to face a bank collapse?

With a slowing economy, falling house prices, a soaring currency, and the threat of a bank failure, the case for rate cuts will only grow. Don't expect any move this week -- or for the next few months. But by mid-2008, the ECB will have joined the global move for lower rates.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net .

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