Trichet, Dodge, King May Follow Bernanke in U-Turn on Policy


Central bankers from Europe's to Canada may follow Federal Reserve Chairman in an about-face, shifting toward supporting economic growth and away from fighting inflation.

Economists are scrapping forecasts for higher interest rates in the euro area, the U.K. and Canada as prospects for expansion weaken, and some even say inflation will soon recede enough to permit cuts. A similar change in outlook may delay expected rate increases in Japan.

``Led by the Fed, central banks are having to change course to avert a U.S.-led global downturn,'' says Paul Sheard, chief global economist at Lehman Brothers Holdings Inc. in New York.

Evidence may come this week as the European Central Bank and the Bank of England each hold policy meetings Oct. 4. While economists don't expect rate cuts this soon, ECB President Trichet and Mervyn King, the U.K. governor, may use the opportunity to signal greater unease about growth. London house prices are falling by the most in three years, while the record- high euro erodes profit at companies such as France's Total SA.

The risk is that, with oil prices above $80 a barrel, rising food costs and limited spare capacity, a tilt toward easier credit might end up fanning inflation. After the Fed on Sept. 18 cut its benchmark rate a half percentage point, more than forecast, investors took out inflation insurance by shifting money from bonds into commodities and emerging-market stocks that tend to perform well when prices are accelerating.

Gold Prices Rise

Gold prices ended last week at a 27-year high of $750 an ounce. Emerging market stocks have rallied almost 20 percent in six weeks, according to an index compiled by Standard & Poor's and Citigroup Inc.

``The problem in cutting interest rates in the current environment is that markets respond by raising inflation expectations,'' says Joseph Stiglitz, a Nobel-laureate economist at Columbia University. ``That's a limitation for monetary policy.''

For now, Europe's biggest central banks are on hold. Economists polled by Bloomberg News are nearly unanimous in predicting this week's policy meetings in London and Vienna will end with the U.K.'s benchmark rate holding at 5.75 percent and the euro area's at 4 percent.

Which Way?

What's changing is the view of where the ECB and Bank of England go from here. Just weeks ago, the consensus was that they would only pause in their drive to push rates higher. That view was reinforced by anti-inflation rhetoric from central bankers themselves. Now, as credit-market turmoil in the U.S. spreads overseas, the pause looks more like a peak.

``We've seen a major change in the gestalt, where the larger risks today are on the side of credit crunch, financial contagion, economic slowdown, rather than the pattern of increased inflation,'' former U.S. Treasury Secretary Lawrence Summers, now a professor at Harvard University, said in a Sept. 27 interview.

With loans harder to get in Europe, economists at Goldman Sachs Group Inc. and Lehman Brothers shelved forecasts that the ECB would raise rates. Lehman calculates that the rise in the cost of credit in European markets has the same effect on growth as a half-point rate increase by the central bank.

Exporters to the U.S. are also suffering as their local currencies surge, with the euro reaching a record $1.419 last week. Paris-based Total, Europe's third-largest oil company, calculates that every 10-cent drop in the dollar against the euro shaves 1.1 billion euros ($1.55 billion) from its operating income. Canada's dollar last month traded at parity with the U.S. currency for the first time since 1976, prompting Montreal- based forest-products maker Tembec Inc. to shutter sawmills in British Columbia.

Fast and Furious

The U.S. economy's slide has come ``faster and more furiously than expected,'' says Erik Nielsen, chief European economist at Goldman Sachs Group Inc. in London, who forecasts growth in the euro area and the U.K. of about 2 percent next year, the weakest in three years. He predicts the ECB will keep rates on hold.


Bloomberg
10/1/2007 7:10:01 AM