Pressure is growing on the European Central Bank to cut interest rates in the medium term after Germany's closely watched Ifo index of business confidence fell more sharply than expected in June, hitting a five-year low.
The gloom hanging over the German economy put pressure on the euro yesterday, which fell by 0.2 US cents against the dollar, before recovering to $0.868. Comments by the US Treasury Secretary, Mr Paul O'Neill, added to the pressure.
Mr O'Neill, speaking on US television on Sunday, repeated that the US government would not change the strong dollar policy. His comments followed the final communique of the weekend G8 summit which had made no mention of the dollar. Some traders had been concerned that the dollar's strength might draw criticism from the G8 and this had helped push the dollar lower across the board last week.
The Ifo, Germany's leading think-tank, said yesterday that its index for western Germany fell to 89.5 in June from May's 90.8. That was the lowest level since August 1996 when we also had a reading of 89.5 points, said Mr Gerno Nerb, head of Ifo's macroeconomic unit.
The Ifo index, seen as an indicator of growth prospects in the 12-member euro zone, is based on a survey of 7,000 German firms. They are asked to assess their current business and their expectations and investment plans for the next six months from a total of 100 points.
"Companies are still sceptical about their profit outlook, particularly in industry," said Mr Nerb of yesterday's figures. All think-tanks in Germany have slashed their growth forecasts for this year, with the Ifo expecting just 1.2 per cent growth. However, it remains anxious to talk up the outlook in Germany.
"We're still a long way off the levels - of around 80 - that we saw in 1993. We can't talk about recession yet," said Mr Nerb.
Germany has been more exposed to the slowdown in the US than its neighbours, but analysts worry that any further slowdown in Europe's largest economy will have a knock-on effect in other countries.
Last month the European Central Bank president Mr Wim Duisenberg restated that it was not the ECB's job to tinker in the euro-zone economy by cutting interest rates, but rather to encourage growth by fighting inflation and promoting price stability. Mr Duisenberg has argued that, despite the German slowdown, the euro-zone economy should still expand by around 2-2.5 per cent this year.
But analysts predict the ECB will have to react in the medium term to this latest gloomy economic data from Germany. "The ECB will definitely take this into account and lower interest rates at some point," said Mr Stefan Bielmeier of Deutsche Bank Research. "Expect a 25 basis-point rate cut after the summer break, more likely in September." Meanwhile, German inflation has fallen for the second month in a row to around 2.8 per cent, down from 3.1 per cent, according to preliminary information released yesterday.
