Duisenberg: 'Economic reaction to war is impossible to judge'

Global tensions from the threat of a war with Iraq are rattling business confidence and the outlook for economic growth is highly unpredictable, Wim Duisenberg, the president of the European Central Bank, said yesterday.

But the euro area's top central banker gave no indication the ECB would act soon to lower interest rates and help offset this uncertainty. Rather, Mr Duisenberg said it was impossible to judge right now the economic reaction to war.

"At this juncture it is not possible to assess how the ongoing geopolitical developments will affect the world economy and, in particular, the euro area economy," he said in a testimony before the Economic and Monetary Affairs Committee of the European Parliament.

While his remarks stuck closely to the ECB's script laid out on 6 February after its governing council decided to leave official short-term interest rate unchanged at 2.75 per cent, Mr Duisenberg did indicate the ECB would take its time to assess the economy's needs.

This disappointed European debt markets, which had rallied earlier in the day expecting Mr Duisenberg to indicate his hand rests firmly on the rate cut lever.

Prices slipped and then recovered, with the March Euribor contract, a proxy for market expectations on official rates, unchanged on the day yielding 2.693 per cent.

Only the Bank of England among major central banks so far has eased monetary policy to offset the drag from war fears. But mounting evidence that Europe's already sluggish economy is slumping has many market participants expecting an interest rate cut in coming months.

These expectations were stoked last week when the three largest economies in the eurozone reported big drops in industrial output. In Germany production tumbled 2.6 per cent in December compared with November, its worst performance in four years.

France's 1.7 per cent fall in December was its steepest in five years. And Italy's 0.6 per cent December fall capped a grim year.

While the Bundesbank yesterday said Germany may yet skirt a recession, it said that Europe's largest economy had stagnated and only an end to geopolitical tensions would bring some light. A prolonged war, however, would lead to sharper falls in German output.

Likewise, the European Commission yesterday said it was likely to cut its 1.8 per cent annual growth forecast for this year.

Indeed, Mr Duisenberg said that the risks are tilted toward slower growth. He also told the European parliament that rising oil prices would damage growth prospects. At the same time, he pointed out the rising euro is helping keep inflationary pressures in check and so far is not hurting the competitiveness of European businesses.