Interest rates are on the way down, but not imminently, the European Central Bank (ECB) has indicated in its latest report.
The tone of the ECB's January report is more relaxed than in recent months, implying that inflation is not likely to be a real problem over the coming months. That would allow the bank to cut interest rates.
However, it does not appear to be in a hurry, despite last week's surprise rate cut from the US Federal Reserve. The Bank of England left interest rates unchanged at its meeting yesterday.
The ECB is thought to be concerned that large-scale wage rises in some of the bigger European economies could still cause a problem. Market sources suggest some governors even suggested a rate hike in December to get the attention of trade union negotiators.
Until the wage rounds are over, a rate cut may be unlikely.
However, the ECB has changed its assessment on inflation. The report notes that "the risks to price stability stemming from the monetary side have become more balanced when compared with the situation some months ago". At that time it saw the risks on the "upside".
It also pointed out that the markets now expect inflation to stay below 2 per cent over the medium term.
One area of uncertainty is the external environment, particularly the implications of the US downturn for other parts of the world.
The Bank of England appeared fairly sanguine about the US slowdown. Many analysts had expected a statement along with its decision yesterday, but none was forthcoming. In September 1998 it issued a statement with its rate decision spelling out the risks posed by the shock waves of the Asian financial crisis.
The absence of a statement suggests that the Bank of England is less concerned about the risks to the British economy from a US slowdown than it has been on past occasions when faced with the possibility of a global slowdown.
Analysts say that if the US falls into a real recession rather than what they now call a cyclical downturn, rate cuts may be forthcoming more quickly from Frankfurt and London.
In further good news for euro zone inflation, the euro continued to appreciate against the dollar yesterday, gaining more than one US cent on the day. The euro rose to $0.9510 from $0.9396 yesterday. It also gained against sterling, closing at 63.63 pence sterling from 63.01p. As a result, the pound closed at 80.66p against sterling from 80.01p.
European data also gave support to the currency. Figures for the German economy showed it grew by 3.1 per cent last year, almost twice the pace of 1999. At the same time, a US retail sales report today is expected to reinforce perceptions that the world's largest economy continues to cool.
There was speculation last night that the Fed could consider another emergency rate cut today. However, ABN Amro chief economist Dr Dan McLaughlin said that was unlikely. "It would mean the Fed had access to far more negative data than the markets have yet seen," he said.
The Organisation for Economic Co-operation and Development said yesterday that US growth could slow more this year than previously expected, to between 2 per cent and 3 per cent. In November, the OECD forecast US expansion of 3.5 per cent in 2001, down from growth of more than 5 per cent in 2000.
Mr Ignazio Visco, the organisation's chief economist, said 3 per cent could be the "upper limit" for euro-zone growth, compared with previous estimates of 3.1 per cent.
He also warned that further cuts in US interest rates could rekindle latent inflationary pressure and make US investments less attractive. A cut in US interest rates and the subsequent drop in return on US assets could prompt an outflow of investments from the country which could affect equity markets, he said.
