Denial in the Euro Zone

Inspired by the Federal Reserve Board, central banks around the world have recently cut interest rates in a bid to give the slowing global economy a much-needed push. But not the European Central Bank. Its governing council left euro zone interest rates unchanged at 4.75% at its last meeting on Feb. 15. Its reasoning: There are "still upward risks to price stability," which make "it risky to push down the price of money." That's nonsense. Inflation in the euro zone is falling. The figure tumbled from 2.9% in November to 2.6% in December on the back of weaker oil prices and a strengthening euro. It's expected to continue drifting down in the second half of the year until it dips below 2%, the upper limit that the ECB maintains is consistent with price stability. Meanwhile, core inflation, which excludes the cost of energy, has never approached 2%.

More important, economic growth in the euro zone has been slowing since it peaked at around 4% last summer. While just-released figures show euro zone industrial output rising faster in December than expected, that's all history. Business and consumer confidence are fading fast. French construction and manufacturing activity are deteriorating. German housing and manufacturing activity are slowing. The sharp decline in U.S. economic growth is clearly pulling European growth down with it.

The euro zone economy is poised between strength and weakness. Big tax cuts are boosting consumer purchases, especially purchases of cars in France and Italy. Employment is still strong in France, and economic growth was surprisingly strong in Italy in the fourth quarter of 2000. There is a decent chance that Europe can sustain its pattern of growth despite the decline in the U.S.--but only if there are major changes in monetary policy.

In this environment, the risky strategy is to hold rates steady and not cut them. What Europe needs is cheaper money fast, to spur growth and the development of a new economy. Without it, the current downswing could turn out to be far more severe than the monetary hawks in Frankfurt are predicting. So at their next meeting on Mar. 1, the governing council should throw its innate conservatism to the wind and lop at least 25 basis points off rates. The euro zone may be a large, relatively self-contained economy. But it is clearly not immune from global economic trends.

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