Which is the odd one out in the following group of central banks: the US Federal Reserve, the Bank of Japan, the ECB and the Bank of England?
The answer is our own ECB, as the others have all cut interest rates in 2001. In the case of Japan, the bank has signalled a zero interest rate policy, while in the UK official rates were recently cut by a quarter of 1 per cent, to 5.75 per cent.
The most substantial change, of course, has been in the US, with this week's half-point cut bringing the total reduction in official interest rates to 1.5 per cent since the turn of the year. The question now is not so much if the ECB will follow but when. April is a possibility, but less likely than May, with the mid-month meeting seen as the prime candidate for an announcement that interest rates in the euro zone will fall.
Yet it has to be acknowledged that the recent rhetoric from ECB officials has not been encouraging for those seeking lower rates. The bank clearly moved into a neutral stance in terms of monetary policy a few months ago but as yet has given few signals that an easing of policy is on the cards in the near term.
That said, a number of developments in the past few weeks may well lead to a change of tone from ECB council members, and the more hawkish remarks from the president of the bank, Wim Duisenberg, will be replaced by more dovish sentiments, as the bank prepares the ground for a rate cut.
The situation in the US has certainly taken a turn for the worse. Company profits there have taken a battering and firms have responded by cutting back on investment, by either cancelling or trimming plans for expansion and laying off workers.
On the consumer side, confidence has been severely dented by the slide in equity markets, and the scale of personal shareholdings in the US is large enough for this to have a substantial impact on household wealth and therefore household spending. Economic growth slowed sharply in the latter part of 2000 (the economy expanded by only 0.3 per cent in the fourth quarter of the year) and a similar pattern is likely in the first half of 2001, with even the possibility of negative growth.
On the positive side the Federal Reserve is well aware of the risks and has acted promptly to bolster confidence by embarking on an aggressive series of rate cuts, which have taken official interest rates there to 5 per cent from 6.5 per cent three months ago. Moreover, the statement accompanying the latest cut stressed that the Fed was monitoring the situation closely, thus opening the way for another rate reduction between now and the next scheduled meeting in mid-May.
To date the ECB has tended to play down the risks of contagion from the US but this is clearly fanciful. In Ireland, we have already seen that US multinationals have scaled back some of their investment plans and the continent is unlikely to remain immune from similar decisions. A second line of contagion flows through international trade, and although exports only account for some 15 per cent of euro-zone GDP, the US slowdown will surely affect activity in the EU via the trade channel.
Finally, we have the stock market, which has transmitted the impact of the US downturn across the globe: most European bourses have fallen by between 15 per cent and 20 per cent this year, despite the ECB's upbeat analysis of the euro zone's growth prospects.
The impact of this negative wealth effect on the European consumer may well be less pronounced than on his American cousin, but it exists nonetheless. Certainly industrial confidence has been hit, with sentiment in Germany particularly vulnerable judging by recent data. The ECB might well point to inflation, which at 2.6 per cent is above its 2 per cent target, as a key factor in postponing or even abjuring a rate cut, but this has not stopped the Fed (headline inflation in the US is above 3.5 per cent) as it is clearly anticipating a decline in inflationary pressure as the economy slows.
What of the financial market reaction to a rate cut? Again there is little to fear here for the ECB: inflation is expected to remain below 1.5 per cent in the medium term, judging by long-term interest rates, and the market is already expecting at least half a per cent cut by year end.
The euro too would probably benefit from a rate cut by the ECB, as investors are not enamoured of a currency backed by an economy which is seen to be facing a sharp slowdown, but where the central bank is reluctant to ease monetary policy. In the past the ECB has moved five months after the US federal Reserve, so on that basis May will see a rate cut in the euro zone, which will be good news for all mortgage-holders in Ireland.
Dr Dan McLaughlin, is chief economist of the Bank of Ireland
