By Anne D. Picker, International Economist,Econoday
Monday, May 14, 2001

The European Central Bank stunned market players and lowered its policymaking interest rate by 25 basis points to 4.5 percent - the same as the U.S. fed funds rate, at least until Tuesday. The decision was surprising given recent hawkish rhetoric from ECB officials indicating that the central bank remained preoccupied with taming inflation, which has been consistently higher than their two percent target. The reasons given for the cut were less than convincing. New information showed that inflation, in the medium term anyway, would fall below two percent. Also, M3 money supply growth, which has exceeded the 4.5 percent target since the euro's inception is actually not that high due to technical distortions. In his press conference following the Governing Council meeting, President Wim Duisenberg said that it wasn't the ECB's practice to surprise the markets. But foreign exchange traders, who were just beginning to believe the ECB's stance on inflation, were in an uproar. The euro, which initially rose on the move, quickly retreated as traders vented their pique at the ECB. The market doesn't take too kindly to surprises.

As expected, the Bank of England took out insurance and lowered its policymaking interest rate 25 basis points to 5.25 percent. This was the third interest rate cut this year. In a statement accompanying the move, the Bank said that world economic prospects had on balance continued to weaken and that the extent and duration of the global slowdown remained uncertain. First quarter output growth was slower than expected and business confidence has weakened. Yet final domestic demand continues to be firm, labor markets remain tight and latest earnings growth figures were higher than their 4.5 percent target, though due largely to temporary factors. Pay settlements remain broadly stable. The Bank of England's goal is to keep inflation - measured by the annual increase in retail prices, minus mortgage interest payments - within 1 percentage point either way of 2.5 percent. Inflation hasn't exceeded 2.5 percent for the past two years, and for the past three months, inflation has been below 2 percent. The next Bank of England meeting is on June 5 and 6 - the days immediately preceding the national election.

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