If the European Central Bank (ECB) was in the business of confounding market expectations, yesterday's 0.25 per cent cut in interest rates would have represented a dramatic coup. However, the ECB president, Mr Wim Duisenberg, has long maintained that he wants to be as predictable and transparent as possible, so yesterday's shock move is sure to undermine the credibility of the ECB and shake confidence in the euro.
For almost a month, Mr Duisenberg and his ECB colleagues have been telling the world that euro-zone growth would remain robust despite the US downturn. They responded sharply to calls for an interest rate cut to boost growth and warned that inflation remained a risk.
Although most economic commentators believe that a rate cut is justified, many had begun to develop a grudging respect for Mr Duisenberg's stubbornness in recent weeks. Indeed, preserving the ECB's credibility as an independent institution that could withstand external pressure appeared to be his primary motivation in resisting demands for a rate cut.
By yesterday afternoon that credibility was in tatters and the ECB president's confused explanation of the reasons behind the decision only made matters worse.
Mr Duisenberg said that the ECB decided to act now because both of the twin pillars of its monetary policy were starting to look healthy. The first pillar is money supply growth and the second is inflation as measured by the Harmonised Consumer Price Index.
Mr Duisenberg noted that M3 money supply growth has been on a downward trend since the spring of last year and that it was 4.8 per cent in the first quarter of 2001, quite close to the ECB's target of 4.5 per cent. But he also revealed that the ECB's measurement of money supply growth has been faulty because it underestimated the impact of non-euro-zone residents' purchases of negotiable paper included in M3. In fact, Mr Duisenberg announced yesterday, money supply growth has probably been below the ECB's target figure for a number of months.
Unfortunately, euro-zone average inflation remains, at 2.6 per cent, well above the ECB's target of 2 per cent. But Mr Duisenberg said that slower economic growth would dampen inflationary pressures and that the temporary impact of last year's oil price rise would soon wear off.
As Mr Duisenberg never tires of pointing out, the ECB's mandate is confined to maintaining price stability, and promoting economic growth is not part of its job.
However, this week's economic figures from Germany were so gloomy that most analysts are convinced that they forced the central bankers to swallow their pride and change their strategy.
Germany, which makes up one third of the euro-zone economy, saw industrial production fall by 3.7 per cent in March - a drop more than three times greater than analysts expected. And unemployment rose for the fourth month in a row - a trend that could damage consumer confidence.
On Tuesday, the Bundesbank president, Mr Ernst Welteke, was still saying that he was not worried about Germany's growth prospects. But by yesterday, he was defending the rate cut with a prediction of lower growth.
"While inflation is still pointing upward, the underlying trend points towards relief. The decision can also be justified with lesser dangers to price stability from economic growth," he said.
Yesterday's rate cut may be too small to prevent a further slowdown in the euro-zone economy. But it could have serious consequences for the ECB - and the euro.
By gambling his credibility on resisting pressure to cut rates, Mr Duisenberg set the stakes high - and the euro is likely to suffer on the markets as a result. Yesterday's move leaves the ECB looking weak, confused and - in the jargon of the markets - "behind the curve" of economic developments.
Mr Duisenberg faces a formidable task as he seeks to regain the confidence of the markets and restore some coherence to ECB policy.
