Worries over growth in US overshadow improving indicators in Europe; no rate hike seen

By Pan Pylas, AP
Wednesday, September 1, 2010

US fears mean risk for European Central Bank

LONDON — Indicators are pointing up at the European Central Bank, which may be about to raise its 2010 economic projections. But that brightening picture is being increasingly darkened by fears about the recovery in the U.S.

That is why ECB head Jean-Claude Trichet is expected to signal that it’s no time to discuss interest rate hikes when he fronts his monthly press conference following the bank’s monthly interest rate decision this Thursday.

The worry is that the loss of momentum in the U.S., the world’s largest economy, will have a knock-on impact in the 16 countries that use the euro, where a bigger-than-anticipated economic rebound has been largely fed by a recovery in global demand. If U.S. demand for German cars wanes, for example, growth in Europe could falter too.

“Trichet may again note still firm short-term macro dynamics in the eurozone, but at the same time acknowledge risks from the slowdown in the U.S. and Asia and that the cyclical upswing will likely remain fragile and uneven,” said Silvia Ardagna, European economist at Bank of America Merrill Lynch.

In August, Trichet sounded cautious even though the impending sense of doom that had dominated much of this year had largely evaporated, following a euro110 billion euro bailout of Greece from the country’s 15 partners in the eurozone and the International Monetary Fund, and a near $1 trillion rescue package for other potentially shaky countries.

Though he said economic growth in the eurozone in both the second and third quarters of this year would be higher than previously anticipated, Trichet warned of the impact from weakness elsewhere — since the last meeting, Japan’s economic outlook has darkened dramatically as the steep rise in the value of the yen pressures the country’s exporters at a time when the economy is barely growing.

While U.S. Federal Reserve chairman Ben Bernanke has conceded that the Fed may have to back another round of monetary easing if the U.S. economy continues to weaken, Trichet will be able to hold off announcing new measures — for now at least.

In the longer term, however, the ECB may have to do more as the eurozone’s recovery could be hurt by any sharp slowdown across the Atlantic.

The ECB, which runs monetary policy for the eurozone, is expected to keep its main interest rate at the record low of 1 percent — and not to change the remaining special liquidity arrangements for the banks introduced at the height of the financial crisis. Higher rates would help ward off inflation as the economy bounces back — but could dampen growth.

The ECB is under no immediate pressure to introduce new stimulus measures because economic growth in the eurozone has been much stronger than anticipated. That is an improvement from just a few months ago when the government debt crisis afflicing a number of countries, most notably Greece, was in full swing.

Figures last month showed that the eurozone economy grew at a quarterly rate of 1 percent in the second quarter of 2010, largely on the back of massive 2.2 percent increase in Germany, Europe’s economic powerhouse — Germany has prospered from the pick up in global demand, which helped the country’s exporters.

The eurozone’s rate, if annualized, would be above 4 percent, way more than the 1.4 percent posted in the U.S. during the April-June quarter.

Given this rosier backdrop, the ECB is expected to revise up its growth projection for 2010 up to around 1.3 percent from the 1 percent predicted in June.

Conversely, the figure for 2011 could well be revised down from June’s 1.2 percent amid mounting concerns about the pace of the economic recovery in the U.S.

Trichet also knows that the cost of sorting out the government debt crisis in a number of countries in Europe will he heavy — Greece’s recession is even more severe than anticipated with its economy contracting by a further 1.5 percent in the second quarter alone.

It’s because conditions in a number of countries are set to deteriorate further as governments try to get their finances back into shape that the ECB will maintain its current lending operations over the coming months.

Even the usually-hawkish head of the Bundesbank Axel Weber has stated that the ECB will continue to offer unlimited money to banks over three-months at the benchmark rate until the end of the year.

“We expect this to be confirmed in a new calendar released after the forthcoming meeting,” said Jennifer McKeown, senior European economist at Capital Economics.

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