Can the European Central Bank Find Stability in the Single Currency?

By Johnson, Mark | Global Finance, November 2001 | Go to article overview

Can the European Central Bank Find Stability in the Single Currency?


Johnson, Mark, Global Finance


EUROPEAN UNION

Europe braces for a global recession that is likely to cast more gloom over the debut of the euro notes and coins.

With barely 10 weeks to go before the euro becomes a physical reality, the central bank responsible for the single currency is still as far away as ever from stamping its authority on the markets. On October 11, the European Central Bank kept interest rates on hold, despite gathering evidence that the euro zone economy might be sliding toward recession.

ECB president Wim Duisenberg justified the decision on the familiar grounds that limiting inflation was the "best contribution" the bank could make to boosting euro zone growth.

Jaded currency traders marked the euro down against the dollar, to $0.91-its lowest level since the September 11 terrorist attacks-but more striking still was the open criticism of the ECB by some member finance ministers.

Lending Rate Cut

France's Laurent Fabius and Luxembourg's Jean-Claude Juncker both expressed their disappointment that the ECB's 18-man governing council had declined to cut the key lending rate from 3.75%.

"The euro zone economy is deteriorating rapidly," says Antoine Brunet, an analyst at HSBC CCF in Paris. "Time is a critical factor when faced with recessionary risk."

Since it was set up in May 1998, the ECB has struggled to establish its reputation-a fact partly reflected in the chronic weakness of the euro.

Ironically, the battered single currency might be in for some respite. Allan Saunderson, chairman of economic analysts Eurozone Advisors, forecasts parity between the greenback and the euro within the next six months, as US recession trims capital inflow and terrorist attacks erode the dollar's safe haven status.

Embattled Central Bank

But that will provide little respite for an embattled ECB. With recession in Europe now a clear and present danger, the Frankfurt-based bank faces it biggest test yet.

Bundesbank president Ernest Weltke admitted in early October that the euro zone growth in 2002 was likely to slip below the long-term trend of 2-2.5%. Others paint a gloomier picture. "Amid global stagnation, we expect that the euro area will grow by just 1.2% next year, after 1.8% this year," says Christel Aranda-Hassel, an economist at Credit Suisse First Boston in London.

The pain is felt keenest in Germany. Federal elections are scheduled for next September, and unemployment-the test on which Chancellor Gerhard Schroder asks the electorate to judge him-is already likely to have crept up over the four-million mark.

Immediately after the ECB decision, Schroder led members of his government in signaling that it might have to take steps to boost economic activity.That's a sharp reversal of tone from just a few weeks ago, when he rebuffed Deutsche Bank chairman Rolf Breuer's suggestion that the government should inject at least 410 billion into the ailing economy. …

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