FRANKFURT, Jan 8 - The European Central Bank defied German-led calls for interest rate cuts on Thursday, saying growing global demand would partly compensate for any damage the strong euro will have on euro zone exports. German Economy Minister Wolfgang Clement led calls for lower rates to offset the currency's dampening effect on economic growth, chiming in with business leaders, and becoming the first senior official of a major industrialised country to do so. At a news conference after the ECB's Governing Council made its no-change decision President Jean-Claude Trichet refrained from directly addressing the soaring currency, which has gained some five percent against the dollar since December alone. "Although recent exchange rate developments are likely to have some dampening effects on exports, export growth should continue to benefit from the dynamic expansion of the world economy," he said. But he said the ECB did not like excess volatility in exchange rate markets. "We have a stake in financial stability, in stability in general and ... we do not particularly like excessive volatility or excessive turbulences," Trichet said.
Financial markets, which had widely expected the ECB would keep its key rate at two percent, were eager to hear what Trichet had to say about the euro. "We are not the prisoner of an equation ... we take all pertinent analysis and we make a judgment," he said, when asked about the strong euro's impact on ECB monetary policy. The euro's gains give the ECB more breathing space, as it saps inflation by lowering import prices. Before Thursday's announcement most analysts had predicted in a poll that the ECB would stay put this month and that it would wait until the second half of 2004 before raising rates as the euro zone economy speeds up.
EURO UP, RATES DOWN
Clement said on Thursday that the euro's strength is a problem for the euro zone economy and puts Germany's 2004 growth forecast at risk. "If you're paying attention to the economic situation, I'm of course thinking about an interest rate cut," Clement said. Belgian Prime Minister Guy Verhofstadt and Germany's DIHK Association of Chambers of Commerce and Industry both called for lower interest rates to help weaken the euro's exchange rate against the dollar. The euro kicked higher just before the decision, then climbed further above $1.27 after markets had earlier been selling euros to hedge against the outside chance of lower rates.
EURO MUDDLES OUTLOOK
If the euro stays strong the ECB may further delay tightening, or even consider lowering rates again, analysts say. On a trade-weighted basis, the ECB's relevant policy gauge, the euro has also gained five percent since November. German Governing Council member Ernst Welteke said this week that the ECB was monitoring the euro exchange rate. But he added: "That is a market price development which central bankers cannot influence." The stronger-than-expected currency means both growth and inflation may pan out lower than the ECB has forecast and the 12 nation single currency bloc may not get close to its cruising speed towards the end of 2004 as now predicted. Euro zone economic sentiment dropped in December, EU data showed this week, casting doubt over any rosy outlook. Moreover, the euro zone's service sector slowed its pace in December, the Euro Zone Services survey showed, even though growth remained strong and a similar survey showed the manufacturing sector picked up speed.//