In November, the Centre for Economic and Business Research (CEBR) claimed that the European Central Bank was ‘trapped’, with a high euro, sluggish growth and high inflation. They predicted that lower inflation this year will rescue the ECB and allow it to lower interest rates without breaking its track record.

Two months later, the situation on the ECB’s official target is looking brighter, as predicted. Annual inflation declined in November to 2.2 per cent from 2.4 per cent in October, just 0.2 per cent above the ECB’s medium-term target. This year, the CEBR expects inflation to decline to 1.7 per cent in the Eurozone, as factors — such as high oil prices, tobacco taxes and prescription charges — which have forced it up this year, recede.

More liberty to cuts rates from the inflation front is needed sooner rather than later, as the situation on the other two fronts has become more troublesome. The euro has continued to strengthen against the dollar, topping $1.35, whilst in December, the euro strengthened against the Yen to reach 141 Yen to the euro, after remaining stable in the previous months. In the latest CEBR Quarterly Business Forecasts, they predict that the euro will rise to $1.45 in the third quarter of this year as investors continue to worry about the US current account deficit and as Asian governments hold out on keeping their peg to the dollar at the
current rates for another six to twelve months. Higher rates in the US and the eventual revaluation of Asian currencies will kick start the adjustment of the exchange rate market, but this may come too late for the ECB’s liking.

On the growth front, the predictions in the QBF are that, without an interest rate cut, annual growth in the Eurozone will slow to less than 1.5 per cent this year from 1.7 per cent last year, before picking up to 1.8 per cent in 2006. The high euro, poor industrial performance, weak export markets on the back of a world slow down and very high savings rates (which will not be aided by slow reform in Europe’s mortgage and pensions markets) will lower economic growth this year.

The latest economic data points to a slow down with annual GDP growth slowing to 1.9 per cent in the third quarter of 2004 from 2.0 per cent the previous quarter and with industrial production declining in October by 0.5 per cent month-on-month. Industrial new orders increased by only 0.2 per cent in the same month — a good gauge of economic activity six to twelve months down the road.

Following 18-months of unchanged interest rates at 2 per cent, CEBR forecasts for eurozone indicators all suggest that the ECB may finally lower rates without damaging its reputation.

Unfortunately for the ECB, the freedom to make its move may have come too late to prevent this year’s Eurozone growth being less than half the 3.1 per cent growth forecast for the US this year.

More details are available in cebr’s Quarterly Business Forecasts, available on subscription from cebr for £250 p.a. for a hard copy or £220 p.a for an electronic version. Telephone 020 7324 2850.