The euro-zone economy is shrouded with gloom, the sovereign-debt crisis is unresolved and the global outlook has deteriorated. This is no time for the European Central Bank, which has raised interest rates twice since April to 1.5% and meets again Thursday, to be moving toward further rate increases. A pause wouldn't damage its inflation-busting credibility.
The deterioration in the euro-zone manufacturing outlook has been remarkable. The Markit Purchasing Managers Index fell to 50.4 in July; a score below 50 signals a recession. New orders declined and backlogs shrank. Spain's manufacturing index plunged to 45.6, driven by weaker domestic and export demand. In Germany, the PMI now languishes at 52, down from a record high of 62.7 just five months ago. Recent data suggest the euro-zone economy grew 0.2% in the second quarter and is slowing further in the third, raising the risk of renewed recession in southern Europe.
That poses a problem for the ECB. President Jean-Claude Trichet has been careful not to commit to future rate raises, but comments from ECB officials have suggested further increases are needed to tackle inflation well above the ECB target of below 2%. Real interest rates remain sharply negative.
Still, further rate rises would spook the markets now that growth is slowing and the debt crisis is no longer confined to Greece, Ireland and Portugal. Since the ECB met in July, Spanish and Italian yields have soared, tightening financial conditions in southern Europe. Further austerity will hit demand, risking a vicious spiral for the economy. Indeed, the market now expects rates to remain on hold this year.
A pause now would invite a debate about whether the ECB was right to start increasing rates at all. But better to pause now than be forced into a more embarrassing reversal if the latest risks to growth materialize.
The deterioration in the euro-zone manufacturing outlook has been remarkable. The Markit Purchasing Managers Index fell to 50.4 in July; a score below 50 signals a recession. New orders declined and backlogs shrank. Spain's manufacturing index plunged to 45.6, driven by weaker domestic and export demand. In Germany, the PMI now languishes at 52, down from a record high of 62.7 just five months ago. Recent data suggest the euro-zone economy grew 0.2% in the second quarter and is slowing further in the third, raising the risk of renewed recession in southern Europe.
That poses a problem for the ECB. President Jean-Claude Trichet has been careful not to commit to future rate raises, but comments from ECB officials have suggested further increases are needed to tackle inflation well above the ECB target of below 2%. Real interest rates remain sharply negative.
Still, further rate rises would spook the markets now that growth is slowing and the debt crisis is no longer confined to Greece, Ireland and Portugal. Since the ECB met in July, Spanish and Italian yields have soared, tightening financial conditions in southern Europe. Further austerity will hit demand, risking a vicious spiral for the economy. Indeed, the market now expects rates to remain on hold this year.
A pause now would invite a debate about whether the ECB was right to start increasing rates at all. But better to pause now than be forced into a more embarrassing reversal if the latest risks to growth materialize.
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