---- by STEVE WHITEHOUSE ----
PARIS (AFX) - The European Central Bank is unlikely to cut interest rates in direct response to last night's U.S. Federal Reserve easing move, but it will come under pressure to ease when the Fed cuts rates again, economists said.
The U.S. FOMC last night cut its key fed funds rate to 5.0 pct from 5.5 pct and its statement on the move made clear that it stands ready to cut rates again before its next formal meeting on May 15.
Another 50 basis point cut would take U.S. short-term rates below those of the ECB, whose main refinancing rate has been at 4.75 pct since October. U.S. rates have been cut by a total of 150 basis points over the same period. "We now have Fed funds just 25 basis points above the ECB's repo rate, with an expectation that Fed funds will move down to 4.5 pct by the May 15th FOMC meeting. So, if the ECB holds off cutting rates until then, rates will cross over," said Julian Callow of CSFB.
"Our view is that the Fed will lower rates to the 4 to 4.5 pct range in coming months, meaning that U.S. short rates probably will fall below those in the euro area," said Jose Luis Alzola of Schroder Salomon Smith Barney.
This would be the first time that U.S. rates have been below average euro zone rates since early 1996, and the first time that they have been below German rates since 1994, he noted. Such a crossover would increase pressure on the ECB to ease monetary policy, economists said.
The ECB has tended to take the view that the U.S. slowdown will be shortlived and expressed confidence that spillovers to the euro area will be limited, but the Fed's statement suggests that it may have to revise that view, economists said.
The FOMC said excess capacity could continue for some time and cited potential for weakness in global economic conditions. Taken together, these factors "suggest substantial risks that demand and production could remain soft", it said.
The ECB will also be getting a similar message from the Bank of Japan, which this week returned to a policy of zero call money rates in response to persistent economic weakness, economists said. The Fed and Bank of Japan moves will both put pressure on the ECB to shift its stance, economists said.
Klaus Zimmermann, head of the DIW, one of the leading German economic research institutes, said that the Fed move makes an ECB rate cut "absolutely necessary". The DIW wants the ECB to cut rates by 50 basis points.
The ECB will need to see statistical evidence of slower growth and reduced inflation risks before it considers a rate cut, but this could start to emerge in the next few weeks, economists said.
This morning's German Ifo business climate index came in well below expectations, providing the first clear evidence of an impact from the U.S. slowdown, economists said.
"We are in a clear phase of cooling down, and Ifo is only the precursor of this," said Stephan Rieke of BHF Bank.
Although euro zone inflation rose to 2.6 pct in February, well above the ECB's 2 pct price stability ceiling, it is expected to decline in the next few months.
And M3 money supply growth has been moving down towards the ECB's 4.5 pct reference value for some months and could even dip below it when February figures are released next week.
CSFB's Callow said the ECB could decide to ease rates at its April 11 meeting, the next meeting to be followed by a news conference. "A 25 basis points ECB move in advance of the end-April IMF meeting, on April 11th, would appear likely," he said.
Alzola of SSSB said he expects the ECB to ease more cautiously, probably reducing rates by 25 basis points in May or June and then holding them steady for a while.
For the moment, the ECB is continuing to stick firmly to its message of robust euro zone growth, limited spillover effects from the U.S. slowdown and no immediate need for rate cuts.
ECB vice-president Christian Noyer reiterated the same line in a speech in Geneva last night. In response to questions following the speech, he reportedly also said that the Fed's policy does not have much influence on that of the ECB, and that it would be normal for U.S. rates to fall below euro zone rates in view of growth developments.
Chief economist Otmar Issing also emphasised the independence of the ECB from the Fed in comments in Munich this morning.
If the ECB is starting to think about a cut in rates, it will have to start to shift its message soon, particularly if an easing move is to be delivered at the April 11 meeting, economists said.
"If this is the way the ECB sees developments, then some recognition that Europe is vulnerable to spillovers and is seeing declining inflationary pressures should become evident in the upcoming speeches by ECB officials," said Callow.