Eurozone interest rates unchanged

The European Central Bank (ECB) has decided to leave the key interest rate for the 12 country eurozone unchanged on Thursday, rather than follow the US Federal Reserve which cut rates on Wednesday.

The immediate knee-jerk reaction after the Fed move was misplaced

Jeremy Hawkins, Bank of America

The decision comes after a promising morning for the euro which bounced back from a brief downward jolt caused by the US rate cut.

A majority of currency analysts had predicted the ECB's no-change decision.

But following the news many experts said a rate cut during the first half of the year was a near certainty.

On London's foreign exchange market, the euro rose half a cent against the dollar after the ECB's announcement and was trading at $0.9450 at 1325 GMT, slightly lower than its highs of the day of about $0.95.

This exchange rate was higher than the level seen when the US Federal Reserve cut its rates, and well above the overnight low of $0.9262.

Rate cut impact

Cutting interest rates in a country normally weakens the currency concerned, as it makes it a less rewarding place for investors to put their money.

In this case, however, the financial markets reacted by rapidly moving into the dollar, on the assumption that the rate cut could provide a massive boost to the flagging US economy because corporate America's borrowing costs would fall.

This, in turn, would help the overall investment climate, and thus increase demand for the dollar once again.

Stock markets around the world reacted promptly as well, posting sharp gains.

However, traders soon took a step back and moved out of the dollar again.

"The immediate knee-jerk reaction after the Fed move was misplaced", said Jeremy Hawkins of Bank of America in London.

His interpretation of the rate cut was more gloomy: "The near-term implication of the Fed's move is that the economy is slowing down more than people anticipated."

Watching the US economy

Europe's single currency has gained steadily against the dollar since about November, when the first signs of economic trouble in the US surfaced.

Still trading well below its launch value of $1.17, the euro has recovered from its record low of $0.8255 in October 2000.

The euro's fate on the currency markets now hinges on how well the eurozone economy is doing compared with that of the United States.

Traders and investors are waiting for Friday's report on the US labour market, and retails sales a week later.

If these data turn out to be 'weak' - pointing to a further dramatic downturn in the economy - then a rate cut of 0.5% may not be enough, says Michael Lewis at Deutsche Bank in London.

Some observers retain hope of another cut in US interest rates later this month.

"Whatever the Fed achieves, we expect the euro will continue to creep higher over the medium term," he said.