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Outlook: ECB looks increasingly out of step

TWO CENTRAL banks have decided to leave interest rates unchanged in the past two days - the US Federal Reserve and the European Central Bank. There is, however, a world of difference in their respective inactivity.

The Fed has done a truly remarkable job of testing the limits of low inflation growth. Rates have been left unchanged despite the 5 per cent- plus growth rate the economy has displayed in recent months. Although some economists are starting to mutter that Alan Greenspan might have to think about raising interest rates quite soon to slow the pace of growth and, more important, halt the stock market bubble, all agree that the US has displayed a spectacular and long-lasting combination of high growth, low unemployment and low inflation.

Euro interest rates are lower, at 3 per cent, but then the European economy is a sad specimen by comparison. Inflation is zero but unemployment is stuck above 11 per cent on average and the long-awaited recovery in growth is threatening to go into reverse. All the recent news from the mainland has pointed to the need, or at least the scope, for looser monetary policy. However, the ever less impressive Wim Duisenberg said again yesterday that he sees no need yet to cut loan costs.

The Bank of England's unexpected activism puts it firmly in the Fed school of monetary policy. Its statement made clear that it sees the inflation target of 2.5 per cent as symmetric - being too far below is as bad as being too far above. Given the uncertain external environment and the absence of inflationary pressures, there was no reason not to cut rates by more than expected. Growth gets a boost with, according to most forecasts, little inflationary danger.

It might yet turn out that both the Fed and the Bank of England have cut too far. In the case of the US, there is growing gloom about the sustainability of the expansion, and its reliance on a buoyant stock market. Some Wall Street bears criticise the Fed's loose policy for puffing up the stock market bubble. The pessimistic scenario is that if inflationary bottlenecks do emerge, the Fed will have to raise rates, the market will crash and there will be a much steeper slowdown than there would have been under a more cautious interest rate policy.

In the UK, meanwhile, there is wide disagreement not just about the outlook for the economy but also about how it is performing right now. Almost invariably in the past 30 years, rapid falls in interest rates have had to be equally rapidly reversed. The hope is that this characteristic has changed under the new policy arrangements, but there is always the danger it has not.

In both cases, it is possible to argue that the monetary authorities have taken risks with inflation, albeit on a lesser scale than in the past. But to make the argument is to highlight the contrast between the Anglo-Saxon and Continental approaches. Turn it around and it is possible to argue that the ECB is taking an equally reckless risk with jobs and growth. Central bankers are bound to make mistakes. The question is which mistake it ought to be at a time when the world is in financial crisis and prices are stable or falling. Just to pose the question is to know the answer.