24 August 2001, 19:00  OUTLOOK Euro zone July M3 to remain high, will not prevent ECB rate cut

FRANKFURT (AFX) - Euro zone M3 money supply growth is expected to remain well above the European Central Bank's reference value in July, but will not prevent the ECB from cutting interest rates by the end of September, economists said. According to economists polled by AFX news, year on year M3 growth in July will come in at 6.1-6.2 pct, compared with 6.1 pct in June. However the three month moving average is seen accelerating to 5.8 pct in May-July from 5.3 pct in April-June. The data is scheduled for release on Tuesday at 10.00 am. The ECB defines year on year M3 growth of 4.5 pct as a reference value for price stability, but economists said the currently persistently high rate of M3 growth will not prevent the ECB from cutting rates on Aug 30 or in September. Economists said distortions to the data are reducing the importance of M3 as a guide to the ECB's monetary policy. M3 is currently corrected for one distortion, created by non resident holdings of money market shares and units. The ECB also believes that another factor is at work upwardly distorting the M3 data -- non resident holdings of money market fund shares and units. It said last month this distortion is inflating M3 growth by 0.75 percentage points evry month. But economists said even when both figures are accounted for, M3 still ends up well over the 4.5 pct reference value, which forms the first pillar of the ECB's monetary policy. The extra growth is thought to stem from investors moving into cash holdings from equities due to the current turbulence on the global stock markets. UBS Warburg economists said if this interpretation is correct, overall the high M3 growth does not harbour dangers for price stability. "If so, the M3 acceleration would not represent a threat to inflation and should not thus affect interest rates decisions," they said in a note to clients. In its August monthly report, the ECB indicated also the acceleration would not persist in the long term. "The increase in the M3 growth over recent months seems to have been driven by effects... which are likely to remain temporary in nature." But the ECB then went on to add it will "have to analyse" the data in the coming months "to confirm this assessment." Economists said for all the confusion currently surrounding the M3 data, the recent moderation in inflation is far more important to the ECB than the acceleration in M3. "M3 is a problem, but there is a pecking order in these targets," said Steve Barrow at Bear Stearns. "And it is inflation that comes first, not M3." Barrow added it would be wrong if the ECB passed up on neccessary rate cuts just because the M3 and inflation figures is are not at their respective target values. "The ECB sets a dangerous precedent if it only cuts rates when both indicators are moving in the right direction," he said. Economists added the credibility of the reference value has been undermined, since the ECB keeps playing down its significance each time it is overshot. They said it should either be lowered in line with the new conditions, or the ECB should consider dropping it altogether. "The ECB quickly has to rethink its strategy. Reference values are useless if the underlying data are distortion prone," said economists at Bankgesellschaft Berlin. Some economists are nonetheless afraid a surprise surge in July M3 could prevent an interest rate cut on Aug 30, which has been widely forecast. When the ECB astonished markets by cutting interest rates on May 10, the bank's justification was a downward revision of M3 growth, they noted.

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