---- by STUART WILLIAMS ----
FRANKFURT (AFX) - The European Central Bank's surprise decision to cut interest rates last week has undermined faith in comments and speeches by ECB governing council members as a reliable guide to monetary policy, putting the bank's credibility on the line, economists said.
They added the ECB failed to provide clear and convincing justification for a move that marked a striking U-turn, and its communication with markets remains the source of great confusion. The current weakness of the euro, which has fallen to around 0.875 usd following the ECB cut, is likely to continue as the market takes out its impatience with the the ECB's communication on the currency, they said.
"The message from Thursday is -- take the comments with a pinch of salt and look at the data," said Guillaume Menuet at 4 Cast.
Days before the interest rate decision, Bundesbank president Ernst Welteke had said the ECB's policy remained one of "wait and see", while chief economist Otmar Issing reaffirmed price stability as the ECB's top priority.
Menuet said the timing of the cut was a deliberate ploy to take the markets by surprise and the bank's comments can no longer be taken at face value.
"The ECB wanted as much of a surprise as possible to boost the euro, and unfortunately it failed."
Julian von Landesberger, economist at HypoVereinsbank, said conflict within ECB governing council has meant comments from the policy makers can only be backward-looking.
Comments only refer back to what is agreed at the previous governing council meeting and thus are of little use in working out future monetary policy, he said.
"If there is a spilt in the governing council this is the only way they can avoid giving conflicting messages, which is an unhappy situation", he said. "For the ECB to have a sensible monetary policy it must be predictable."
Economists said the surprising nature of the interest rate cut may have been a product of a conflict on the ECB governing council, with prolonged disputes making the further course of monetary policy highly unpredictable.
"One explanation for the ECB 's recent activities is deep disagreement about what needs to be done next," economists at UBS Warburg said.
"If so, the situation becomes very difficult to predict, as whoever won the debate may lose next time or win even more rate concessions," they added in a note.
Denis Errica at Banca Internazionale di Gestione said the cut was particularly poorly timed as it came a day before ugly inflation figures from Spain, the Netherlands and France.
"The ECB had gained credibility by keeping rates on hold but then it cut against the evidence of statistics", he said. "(Now) they have lost credibility because they changed their mind and for us did not justify it."
HypoVereinsbank's von Landesberger said it will take the ECB some time to regain the capital flows lost when investors took fright at its unpredictable monetary policy.
"If I cannot read the central bank of a country then I would be very cautious about investing in that country," he said. Some economists were not persuaded by ECB president Wim Duisenberg's argument that the recent discovery of substantial distortions in M3 data from non-euro area residents' purchases of negotiable paper means there are no longer risks to price stability from the monetary side.
Duisenberg said the distortion amounted to 0.5 pct, which would mean March's high M3 growth figure of 5.0 pct would come down to the ECB's reference value of 4.5 pct when cleansed for the distortions. "New facts lead to new assessments and sometimes they lead to new conclusions", he said.
"The M3 argument is not very convincing", said Ulla Kochwasser at IBJ Research.
"One has to bear in mind that money supply grew way above 4.5 pct for some time and it takes a while until those past excessive increases find their way into higher prices."
It is also highly improbable the ECB only became aware of the distortions a few days before the governing council meeting, as claimed by Duisenberg, economists said.
Duisenberg said at the news conference M3 was only one of many factors that prompted the ECB to cut rates and economists said the real reasons behind the move remain shrouded in mystery. Economists at CreditSuisse FirstBoston said a relative lack of pressure from euro zone finance ministers for a rate cut last week may have allowed the ECB to make the move without giving the appearance that they were caving into pressure.
"One might wonder what effect the absence of interventions by finance ministers in the past fortnight might have had on the ECB," they said.
Yesterday, Bundesbank president Ernst Welteke said the ECB decision to cut rates showed its independence from "certain finance ministers from neighbouring European countries."
However economists said while inadequate communication marred the rate cut, the ECB's credibility should survive long term as the deteriorating economic environment required a relaxation of monetary policy.
They said the cut followed an alarming collapse in German industrial output, which showed the manufacturing sector in Europe's largest economy verging on recession.
Klaus Baader at Lehman Brothers said the decision shows the ECB is now looking beyond keeping inflation under control over a 2-4 month horizon, and has adopted a more forward looking perspective. "Nobody thinks this was a major policy mistake, and even if it was the ECB is in the most excellent company," he said.