New Central Bank Trims European Interest Rates

In an aggressive move designed to provide an economic fillip to a beleaguered region, the fledgling European Central Bank lowered interest rates Thursday by half a point to 2.5%.

The first major policy dictate of the bank’s short life reflects growing concern over a broad slowdown in economic activity across Europe. The intention is to increase investment and spur growth.

“The European economy overall has been underperforming,” said Jeffrey Schott, senior fellow at the Institute for International Economics in Washington. “This cut should be very welcome.”

Aside from the U.S., Europe has been the world’s only regionwide bastion of economic growth. But flagging strength here increases the pressure on the U.S. to carry the fragile global economy as the world’s only healthy market for other countries’ products. And the health of Europe, as the largest regional market for U.S. exports, is important to sustaining the U.S. economic boom.

“The concern of industrialized nations is that the U.S. economy will slow before Europe, Japan and the rest of Asia pick up,” said Eckhart Schulte, senior economist at the Frankfurt office of the Industrial Bank of Japan. He hailed the move: “In a sense, the rate cut could be part of a global strategy.”

The size of Thursday’s reduction surprised observers; it was twice the quarter-point cut many had expected. Others, however, were surprised the bank board acted at all.

Some skeptics have doubted all along that board members could act in concert for the benefit of all 11 European nations that formed the monetary union. Thursday’s action was the first the central bank has taken on the highly politicized issue of interest rates. The bank was formed in conjunction with the Jan. 4 launch of a common currency, the euro.

The central bank, Europe’s equivalent of the U.S. Federal Reserve, regulates monetary policy, sets interest rates and makes short-term money available to big commercial banks.

A decision on cutting the refinancing rate--comparable to the U.S. federal funds rate, the overnight loan rate among banks--had become a political football and was loudly favored by former German Finance Minister Oskar LaFontaine before he resigned in February, partly over monetary policy differences with Chancellor Gerhard Schroder.

Now that that action has been taken, Jens Dallmeyer, senior economist at Deutsche Bank in Frankfurt, cautioned that the effect on consumers could be more psychological than practical since mortgage and consumer credit rates won’t immediately be affected.

But Dallmeyer said the rate cut is a signal from the bank that annualized inflation, currently less than 1%, should remain low: “It’s a sign that the overriding goal and responsibility of the bank--monetary stability--is not in danger.”

What is beyond dispute is that Europe’s economy needs a boost. “Euroland” unemployment is expected to reach 10.6% in 1999, with economic growth expected to register only 2%, down from 3% last year.

The rate cut puts further downward pressure on the beleaguered euro, which has already lost 8% of its value against the dollar since its introduction. The euro fell to $1.074 on Thursday from $1.077 on Wednesday.

But by lowering interest rates, the bank hopes that businesses ranging from fishing fleets in Spain to heavy equipment manufacturers in Germany will borrow money, invest more in growth, create jobs and boost trade.

“It will make Europe a better economy,” Plum Shipton, an equity strategist at Merrill Lynch in London, said of the rate cut. “Some countries are already on the way up, like Ireland, Spain and Portugal. But this will help those that are in worse shape, like Germany and France.”

The Bank of England also lowered its benchmark interest rate Thursday, cutting it from 5.50% to 5.25%, the latest in several reductions that have brought rates down from 7.50% as recently as October. Britain has not yet adopted the euro and is not a member of the ECB.

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Key Short Rates

The European Central Bank and the Bank of England both cut their key short-term interest rates on Thursday. Here are the main central bank rates for leading world economies:

Britain: 5.25%

Canada: 5.00%

United States: 4.75%

Euroland: 2.50%

Japan: 0.50%