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Old 07.07.2005, 13:31   #1
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Default ECB Keeps Interest Rate at 2% as Euro Decline Supports Economy

ECB Keeps Interest Rate at 2% as Euro Decline Supports Economy
July 7 (Bloomberg) -- The European Central Bank set its benchmark rate at a six-decade low for a 26th month today, ignoring calls for a cut amid evidence the euro's decline is helping the region's economy.

The ECB's 18-member governing council held the refinancing rate at 2 percent after meeting in Frankfurt, the bank said in a conference call. All 43 economists surveyed by Bloomberg expected policy makers to keep rates on hold.

Politicians including Italian Prime Minister Silvio Berlusconi and German Economy and Labor Minister Wolfgang Clement have urged the ECB to lower rates as oil prices above $60 a barrel and unemployment near a five-year high force governments to pare economic growth forecasts. The euro's 11 percent decline against the dollar this year may alleviate the need for a rate cut as it makes European goods cheaper abroad.

``The foreign exchange market is already delivering an easing in monetary conditions without the ECB having to do anything,'' Guillaume Menuet, senior economist at Moody's Investors Service in London, said before the decision was announced. ``It's very much a case of staying put for the ECB.''

Factory orders in Germany, Europe's largest economy, rose 2.7 percent in May, driven by a 5 percent jump in foreign orders, the government said yesterday. Business confidence in the dozen euro countries rose for the first time in nine months in June and an index of manufacturing increased, helped by the currency's drop.

ECB President Jean-Claude Trichet will hold a press conference on the bank's decision at 2:30 p.m. in Frankfurt.

London Explosions

The Bank of England kept its rate unchanged at 4.75 percent today. Bond yields fell and stocks slumped after reports of explosions in at least seven locations in London. The German 10- year bund yield dropped to a record low of 3.08 percent. The Dow Jones Stoxx 600 Index lost 3.6 percent to 269.80 as of 12:02 p.m. in London, the biggest decline since September 2002.

Investors also increased expectations for an ECB rate cut, with the implied rate on the three-month contract for December settlement falling to 2.03 percent at 1:15 p.m. in Frankfurt from 2.09 percent yesterday. The contracts settle to the three-month inter-bank lending rate for the euro, which has averaged 15 basis points more than the ECB's key rate since the currency's launch.

The ECB hasn't changed rates since June 2003 as economic growth in the region is set to lag behind the U.S. for the 13th year in 14, according to European Union forecasts. The euro region depends on exports of goods and services for the equivalent of 20 percent of gross domestic product, twice as much as the U.S., making it vulnerable to swings in the exchange rate.

Euro Drop

A euro bought $1.2000 at 11:24 a.m. in Frankfurt, down from a record $1.3666 on Dec 30, making European exports cheaper abroad and bolstering profit overseas for European companies. The currency's drop also amplifies a 40 percent increase in oil prices this year, increasing concern about inflation.

``Underlying domestic inflationary pressures remain contained,'' Trichet told the European Parliament July 4. ``However, upside risks to these projections remain,'' relating ``mainly to oil price developments, indirect taxes and administered prices.''

Crude oil for August delivery rose to a record $62.10 in after-hours electronic trading on the New York Mercantile Exchange today. The contract was at $60.30 at 11:44 a.m. Frankfurt time. The ECB is worried higher oil costs will exert upward pressure on other prices such as wages, leading to more lasting inflation.

European inflation accelerated to 2.1 percent in June from 2 percent in May, according to the initial estimate published by the European Union's statistics office in Luxembourg on June 30.

Excess Money

Adding to inflation risks, the lowest credit costs since at least 1946 have pumped more money into the $9.3 trillion economy than needed for inflation-free growth and fueled house price increases of more than 10 percent in France, Spain and Ireland.

M3, the ECB's measure of money supply, rose 7.3 percent in May from a year earlier after growing 6.8 percent in April. The bank says a rate above 4.5 percent risks fueling inflation. M3 growth rates have exceeded 4.5 percent every month since May 2001.

``We have a sort of liquidity trap,'' said Ulrich Hombrecher, chief economist at WestLB AG in Dusseldorf, in an interview on Bloomberg television this morning. ``Credit growth is rising and rates are very low, and yet investment activity is not rising. If an engine is broken you don't try and step on the gas.''

Gathering signs of weaker expansion in Europe have led politicians to criticize the ECB for failing to stimulate growth with lower interest rates. The ECB's monetary policy has been ``destructive,'' Berlusconi said in April. Clement complained on June 29 that the bank's policy ``isn't necessarily in our interest.''

Political Pressure

The European Commission may lower its 2005 growth forecast for the euro region for a third time in eight months if oil stays at $60 a barrel, European Union Monetary Affairs Commissioner Joaquin Almunia said June 25.

The Dutch economy, the fifth largest among the dozen nations sharing the euro, shrank 0.8 percent in the first quarter from the fourth, its biggest contraction in almost 12 years, the Netherlands-based Statistics Bureau said yesterday.

``Europe is lagging behind global economic developments,'' Christoph Leitl, president of Brussels-based Eurochambres, which represents 17 million companies, said in a telephone interview before the ECB's decision. Growth ``is shamefully low and not enough to reduce the horrid unemployment figure.'' The euro region's jobless rate was 8.8 percent in May.

A rate cut ``would be an important psychological signal,'' Leitl said.

For now, the ECB is showing no sign of caving in to political pressure. ECB council member Jaime Caruana said in an interview with a Spanish newspaper published yesterday that lower rates wouldn't solve Europe's economic problems. This week Trichet said rates are low enough to support growth, and council members Christian Noyer and Klaus Liebscher said the ECB's policy was ``accommodative.''

Bundesbank board member Hans Reckers said in an interview on July 5 that the ECB's key interest rate may ``stay unchanged at 2 percent until the summer of 2006.''

To contact the reporter on this story:
Matthew Brockett in Frankfurt at [email protected].

Last Updated: July 7, 2005 07:45 EDT
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Old 07.07.2005, 13:33   #2
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