Late yesterday the Federal Reserve Board announced another interest rate cut, the sixth since the start of the year. It is a clear sign that the Fed remains concerned about the state of the US economy. Confidence amongst US consumers and business remains fragile and the outlook is thus uncertain. Worryingly, there recently have been signs that this economic malaise is spreading across the Atlantic, with the German economy weakening sharply, threatening a more generalised downturn in the main Continental euro zone economies.
The European Central Bank must now be increasingly concerned about this possibility. At last week's meeting in Dublin the ECB decided to leave interest rates unchanged. However, unless the economic signals improve in the meantime, it would be well advised to follow the Fed's lead when it meets in July and reduce interest rates again, as a way to support economic growth.
There are increasing signs that the difficulties in the US are knocking on to Europe. The German economy, heavily reliant on manufacturing industry, is suffering as a result. The latest data for confidence in German industry, published on Friday, showed a sharp fall in expectations for future prospects. Already there are signs that French growth may also be slowing, while across Europe the technology sector is in difficulty.
The ECB has been cautious in its response to date, announcing one interest rate reduction last month of 0.25 of a percentage point. One difficulty for the bank is that inflation has remained stubbornly above the ECB's 2 per cent guideline level. The outlook now is for a gradual decline in the inflation rate - indeed the prospect that this would happen was used to justify the May rate reduction.
Is another rate cut in the offing? The financial markets seem to think so, betting that the ECB will respond to the weakness in the European economy. Taking a short-term view, lower interest rates would not necessarily be good news for the Irish economy, where growth - although slowing - remains strong and the rate of inflation remains above the average. However, in the longer term, it is very much in the Republic's interest that European growth remains buoyant, at a time when the US market is weak.
Unfortunately, even lower ECB interest rates cannot guarantee strong growth across Europe. After all, the US has now cut rates six times and the impact remains uncertain. The best hope is that lower borrowing costs on both sides of the Atlantic will lead to gradual recovery late this year and in 2002. Given the overwhelming evidence of slower growth, the ECB must follow the Fed and move soon to again reduce interest rates.