European Central Bank President Wim Duisenberg says no interest rate cuts are coming this summer.
July 9, 2003: 9:47 AM EDT
FRANKFURT, Germany (Reuters) - The European Central Bank is set to hold interest rates steady this week, a point underlined Wednesday by European Monetary Affairs Commissioner Pedro Solbes, who said rates at two percent "seem suitable."
ECB President Wim Duisenberg sent a clear message last week that no rate cuts are coming this summer, saying: "We have done our part" and it is now up to governments to adopt market reforms to boost growth.
Solbes echoed this view in a newspaper interview published Wednesday saying that beyond low interest rates, structural reforms now are needed to boost confidence and improve Europe's economic competitiveness.
Duisenberg is expected to jump on this point at his news conference after the ECB meeting Thursday and lecture governments to speed up reforms and cut their budget deficits -- particularly Germany, Italy and France, which are set to break budget rules.
With these top three economies in the 12-nation euro zone all moving toward budget-busting tax cuts, some ECB watchers say the ECB may prove reluctant to cut interest rates in September or even October, especially if inklings of an economic recovery are starting to emerge.
"Unsustainable government debt levels pose a serious threat to the bank's mandate of keeping inflation at a low and stable level," said Wim Koesters, economics professor at Ruhr University Bochum and a member of the ECB Observer think tank.
One major hedge fund manager, who asked not to be named, said he is betting on no ECB rate cut in September while governments sort out their 2004 budget plans.
Most analysts in a Reuters poll last week said they expect a September rate cut, but financial markets are growing more dubious. Euribor futures are pricing roughly a 50 percent chance of a 25 basis point (one-quarter percentage point) move in September, and a 75 percent chance by December.
Duisenberg fired the broadside about fiscal laxity last week, when he warned the European Parliament worried about sluggish growth that governments can no longer hide behind the ECB. Solbes made the same point in Wednesday's newspaper interview.
Bundesbank Chief Economist Hermann Remsperger also told a newspaper this week that monetary policy would be made more difficult if Germany again breaches the European Union's rule to keep budget deficits below 3.0 percent of gross domestic product.
ECB Observers in a report issued Tuesday threw their academic weight behind fiscal austerity saying it is essential to the ECB. Abandoning the budget rules threatens the very economic framework that underpins the ECB -- achieving price stability through fiscal and monetary discipline.
With weak growth, high unemployment and low inflation all reasons for politicians to demand an inflationary monetary policy rather than pursue politically painful spending cuts or tax increases, budget rules become even more important, it said.
Ansgar Belke, economics professor at the University of Hohenheim, said he has developed an economic theory called the option value of waiting that proves delaying budget reforms only harms growth prospects.
It shows that because businesses and consumers know that tax cuts eventually must be paid for, they delay economic decisions, increase their savings rates and do not take advantage of cheaper money.
"Hence it makes more interest rate cuts ineffective," Belke said.
Julian van Landesberger, economist at HVB Group, agreed budget issues are a problem. "Fiscal laxity is definitely going to be worrisome for the ECB," he said.
But if governments accompany the sugar pill of tax cuts with the harsh medicine of pension and labor market reforms, as Germany is doing, the ECB will be sympathetic, he said.
Moreover, Anthony Thomas, European economist at Dresdner Kleinwort Wasserstein, said the ECB will not have the luxury to delay cuts too long.
"Chance would be fine thing," Thomas said. "The European economy is so weak it needs all the stimulus it can get."
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