Page last updated at 17:55 GMT, Thursday, 4 December 2008

Is the ECB dragging its heels?

By Ben Shore
Europe business reporter, BBC News, Brussels

European Central Bank (ECB) Chairman Jean-Claude Trichet
ECB boss Trichet has overseen a

The European Central Bank has cut the key interest rate for the 15 countries that use the euro from 3.25% to 2.5%.

Never before has the bank delivered such a large cut, and yet the reduction is deemed modest compared with those delivered by other central banks, such as the US Federal Reserve or the Bank of England.

So why is it that the ECB rate reductions are relatively modest?

One answer is that some European economies are growing and are expected to continue growing.

For example, Slovenia could be on course for an impressive 3% increase in its economic output, or GDP, in 2009, and several other countries such as Greece and Finland will not be far behind.

Of course, those countries do not play as significant a role in the Eurozone economy as France and Germany.

But in explaining the comparatively conservative cuts of the ECB it is worth bearing in mind the incredible diversity of the economy it must set rates for.

Inflation worries

And then of course different people naturally put different emphasis on the same information.

High commodity prices until the summer of this year had a significant impact on the thinking of Europe's central bankers.

The rising cost of food and oil played into a deep strain of European thinking that despises rising prices.

There is a general feeling that the ECB over-emphasised the inflation numbers earlier this year, without factoring in the generally weak state of the world's economy.

Demand has now collapsed so there's no need to worry about rising prices.

Effective measure?

Inflation in the Eurozone is down to 2.1%, almost exactly the target the bank is required to aim at.

An oversized 100 euro banknote is held in front of the headquarter of the European Central Bank in Frankfurt
Inflation is no longer a worry in the eurozone

But the inflation numbers came out on Friday last week and the ECB would have known the figures before then.

So why, when the Bank of England has cut rates by 1%, after a 1.5% drop last month is the ECB still so slow to cut rates over there?

Well, there is also the element of authority.

How much influence do rate cuts actually have on the lending that takes place in the real economy?

At the moment, the answer is: not much.

Even though commercial banks can get cheap money from the central banks, they are all worried about having enough cash in reserve to see out the crisis.

They would rather keep the money locked in the basement than risk losing it in a shrinking economy.

In other words, why would the ECB wish to fight a battle it cannot win?

Dry powder

Perhaps, also, there is a danger in getting too caught up in comparisons between different central banks.

The fact is, they are all cutting interest rates.

If there is a slight difference from one to another then at least there is a consensus that times are going to get very tough indeed, and in that thought perhaps there's a final explanation for the ECBs current thinking.

It does not want interest rates to go too low now, because it wants to keep some powder dry for when things get worse.

Are you affected by the issues raised in this story? What is your reaction to the European Central Bank's move? Is this a way to get the economy in the Eurozone out of the crisis? Send us your views using the form below:

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A previous version of this story contained data relating to the economies of Slovakia, Bulgaria and Poland in a way that implied they were part of the eurozone.

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