Mon, May 14, 2001 page21

• Central bankers sing in harmony

  GLOBAL ECONOMY The European Central Bank's surprise move to lower borrowing costs is the strongest sign yet that a recession will be averted

  • By William Pesek Jr / BLOOMBERG
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  Wim Duisenberg isn't known as a touchy-feely guy. Even so, it's tempting to picture the European Central Bank president standing in a circle with his counterparts from the US and Japan, holding hands, swaying back and forth and singing, ``We are the world.''

  Against his own better judgment, Duisenberg gave in to the intensifying chorus calling for lower European interest rates. The ECB's move to do just that means every major central bank is now stimulating growth. As we've seen in recent years, this collective roll-up-our-sleeves-and-get-serious approach by policy makers can have powerful results. One recent episode was in 1998; central banks slashed rates and economies snapped back.

  The ECB's surprise move to lower borrowing costs is the strongest sign yet that a global recession will be averted this year. An international recession, seen as a distinct possibility a few months ago, now seems highly unlikely. That's because central banks around the world have been pumping up their respective money supplies with an enthusiasm rarely seen. Since the euro zone economy is roughly the size of the US, lower rates there will help.

  "The sharp bond-market sell-offs following the cut was the telling move of the week," says Michael Hartnett, a London-based strategist at Merrill Lynch & Co.

  Duisenberg's move to lower the benchmark rate 25 basis points to 4.5 percent came at time when euro zone inflation is above the ECB's 2 percent target indicated he thinks the risks of a global recession outweigh concerns about higher consumer costs. That about-face on the part of man who up until the last second insisted he couldn't cut rates could be a watershed event for the "global reflation" trend bond investors fear.

  "All the world's money printing machines are operating at high capacity," says David Kotok, chief investment officer at Cumberland Investment Advisors in Vineland, New Jersey.

  "Globally, short-term interest rates are headed lower. All this stimulus taking place this year means economic recovery, inflationary pressures and rising bond interest rates next year."

  With the US and Japan experiencing sluggish growth, at best, policy makers in Europe and elsewhere are bracing for slower global growth. That's what IMF Chief Economist Michael Mussa had in mind recently when he said the global economy isn't in crisis yet, but a "deeper and more prolonged downturn is clearly possible."

  It's that scenario central bankers are rushing to avoid.

  The US Federal Reserve is widely expected to toss additional stimulus at the US economy tomorrow, when policy makers meet. It would be their fifth rate cut this year; so far the Federal Open Market Committee has trimmed two percentage points from the federal funds rate, which is now 4.5 percent.

  The FOMC is expected to trim another 25 to 50 basis points from its overnight bank-lending rate on May 15.

  Already there's considerable evidence that the economy may have bottomed. The 0.8 percent jump in retail sales in April and big increase in the University of Michigan's consumer sentiment index in May are the latest signs. The University of Michigan's barometer rose to 96.2 in May, the highest level in four months.

  US retailers like Wal-Mart Stores Inc and AnnTaylor Stores Corp are reporting healthy year-over-year sales growth.

  The stock market, meanwhile, is staging a quiet rebound, a dynamic that appears to be boosting consumer and business confidence. In April alone, the Dow Jones Industrial Average rose 9 percent, while the NASDAQ Composite Index jumped 15 percent.

  Corporate credit quality -- a major concern a few months ago -- also appears to be on the mend, according to a report by Moody's Investors Service. Company credit ratings are on the rise, braking a three-year slide and suggesting lower borrowing costs within the next six months. Moody's has raised ratings on 4.2 companies for every 10 it lowered since April 1, compared with 2.9 upgrades for every 10 cuts in the first quarter. The ratio was 1 to 1 in 1998.

  Still, Fed officials have made it clear they fear the economy remains vulnerable to slower growth this year. While inflation is creeping higher and unnerving the bond market, the US central bank worries that trillions of dollars worth of wealth erased by the stock market's losses pose even bigger risks.

  Recent economic news -- including the quarter of a million jobs lost in April -- "still argues for the FOMC to finish the run of medicine," says Neal Soss, chief economist at Credit Suisse First Boston Inc in New York.

  Japan, of course, remains in perpetual monetary-stimulus mode. Short-term rates are at zero and the Bank of Japan has gone beyond that, pumping up the nation's money supply. Until politicians get serious about fixing Japan's troubled banking system and companies restructure, the BOJ has little choice but to keep printing yen, says Richard Jerram, chief economist at ING Barings Securities (Japan) Ltd in Tokyo.

  Other major central banks are cutting too. The Bank of Canada has been lowering borrowing costs this year amid signs of softening domestic growth and mounting weakness in its biggest trading partners. The Bank of Canada is expected to move again later this month. The Bank of England also has trimmed borrowing costs three times this year.

  With central bankers again taking a we-are-the-world approach to policy making, the risks of a global recession are waning.
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