Published: May 23 2001 18:58GMT | Last Updated: May 23 2001 19:07GMT Slower growth and rising inflation: which is the greater danger? After a series of confusing signals in recent weeks the European Central Bank on Wednesday left the markets guessing by holding its interest rate unchanged at 4.5 per cent. Before its quarter-point rate cut on May 10, the Bank was suggesting that control of inflation was its priority. But that cut - although partly justified by slower monetary growth - seemed to show a switch of focus to the weakening economy. Since then both indicators have been looking worse. This week the German Ifo business index declined to 92.5, its lowest since May 1999, while Wednesday's first-quarter output data showed growth slowing to an annual rate of 2 per cent, compared with 2.6 per cent in the previous quarter. In France there was also a marked slowdown. In response to the chill economic winds from the US, investment has been scaled back in both countries and consumers are beginning to keep their money in their pockets. Meanwhile, regional figures suggest that German inflation is rising to about 3 per cent. In the euro-zone as a whole, the April harmonised inflation rate of 2.9 per cent was well above the ECB's target of 2 per cent. This unhappy combination is only a shadow of the "stagflation" of the 1970s, when rising oil prices pushed European inflation to a peak of more than 13 per cent while growth stalled. But the parallel is uncomfortable. With more than 8 per cent of the euro-zone labour force still unemployed, there ought to be ample room for non-inflationary growth. But in spite of a welcome pick-up in France since 1998, the economic performance of the zone has been disappointing, a fact reflected in the continued weakness of the euro. In its recent report on Germany, the Organisation for Economic Co-operation and Development estimated that underlying growth potential was only 2 per cent a year, far behind the US. Until Europe can free itself from the restraints of excessive regulation and other obstacles to efficient markets, the ability of monetary policy to pump up demand will be limited. Still, slower growth and steadier oil prices are expected to take the pressure off inflation, while a further slide in confidence and output remains all too possible. The ECB should therefore stand ready to ease. It must be seen to focus on expected rather than actual inflation. And since market uncertainties may contribute to inflation by helping to keep the euro depressed, it must also be clearer about how it sees the competing pull of slow growth and rising prices.
