Should the ECB follow FED and the Bank of England with respect to the interest rate cutting?

One of the main concerns of the ECB is keeping inflation at a reasonable level, which is considered to be 2 % in the Euro zone. In January inflation reached a fourteen year high (3.2%) among the countries that share the euro as the national currency. On the other hand the economy shows signs of decelerating, in response to the financial turmoil induced by the subprime crisis in US, a strong euro and rising oil prices.

In January, the service sector of the euro zone, which is also the most representative one, grew at the slowest rate in more than four years. Rising food and energy prices led to a decrease in consumption and to the fact that consumers were the most pessimistic in two years. The rising of prices in strategic areas led to demands of increasing salaries from employees. On the other hand employers in various fields increased their prices on the basis of increasing input costs, thus contributing to the inflationist spiral.

Even if on the short term, the ECB kept its course and did not follow the decisions made by FED and BOE (Bank of England), there is a feeling among investors that on the medium term, ECB will lower the key interest rate, thus supporting investments, but compromising the inflation target, which ECB did not meet in the last nine years. Here there is another interesting question: Should Central Banks meet investor’s expectations? Or as Alan Greenspan put it: “Should Fed answer to Wall-Street or Main Street”? The optimum would be reached if Central Banks could tackle the stock market as the main stream of the economy from a macroeconomic perspective. It would be easier if Wall Street would be the same with Main Street. But unfortunately, this happens only in theory, which states that the stock market should reflect the economic realities. But it is obvious that this does not happen for many countries.

By keeping the key interest rate at 4%, the ECB tried to anchor the inflationist expectations. Even if BOE cut interest rates two times in three months, to 5.25% and Fed made two reductions in only one month to 3%, ECB considered that the main objective is price stability, although there is a concern regarding economic slowdown.

Although the ECB did not follow FED and BOE, because it considered that the growth of the economy was not at a disastrous pace, the question I have raised in the beginning of the article still remains without an easy answer. We will see the impact of these measures on the financial markets and we will analyze the decision from a more objective manner, which is ex-post.

Alexandra Slăvilă