The European Central Bank (ECB) looks certain to leave interest rates unchanged today after an unexpected surge in German industrial output. Output rose 1.8 per cent month-on-month in August, helped by a sharp increase in eastern German activity and surpassing all forecasts.
ECB president Mr Wim Duisenberg all but ruled out an interest rate cut on Tuesday when he told the European Parliament that, although inflationary pressures were falling, other factors such as oil prices continued to give cause for concern.
"We are of the opinion that the risks to price stability over the medium term are at present balanced. We thus consider the current level of the key ECB interest rates to be appropriate," he said.
Yesterday's strong data from Germany, the euro-zone's biggest economy, dashed any lingering hope among analysts that the ECB's governing council will bow to pressure to cut rates when it meets in Frankfurt today.
The ECB's critics argue that, with inflation close to the ECB's target of 2 per cent, an interest rate cut would represent no threat to price stability.
They suggest that, although money supply growth is strong, this is a consequence of the flight from the stock market.
The ECB claims that analysts overestimate the potency of an interest rate cut in boosting economic growth. "It is well established that monetary policy can only control price developments over the medium term and cannot have an impact on output beyond the short term. Monetary policy can certainly not heal structural problems in the economy, such as those underlying the high level of unemployment," Mr Duisenberg said on Tuesday.
But critics point out that when the ECB cut rates to 2.5 per cent in April 1999, the euro-zone economy recovered within months and enjoyed a good year of growth in 2002.
Today's meeting has been overshadowed by the apparent unravelling of elements of the Stability and Growth Pact that obliges euro-zone governments to limit their budget deficits.
In Luxembourg on Tuesday, EU finance ministers effectively postponed a 2004 deadline for governments to bring their budgets close to balance. France's finance minister, Mr Francis Mer, signalled that he would ignore even the new, more flexible rules and proceed with plans to boost public spending and cut taxes.
Addressing the French National Assembly yesterday, Mr Mer insisted that his defiance did not represent an abandonment of the pact.
"We reached a common position, a consensus, on declaring that the Stability and Growth Pact remains the Bible for definition of policy for the different countries," he said.
In his testimony to the European Parliament on Tuesday, Mr Duisenberg repeated his opposition to any weakening of the pact.
"If the pact is to work efficiently, all countries with remaining imbalances must commit themselves to implementing a clear consolidation strategy.
"Such a strategy should specify a credible adjustment path with significant improvements in the cyclically-adjusted budget balance every year. This path should be followed strictly and completed within the shortest possible time frame," he said.
