Inflation target

The ECB has a 2% or lower inflation target for the medium term, but annual inflation is approaching 3% for the first half of 2008. However, economist Steve Affinito told BloggingStocks on Wednesday, while willing to grant the ECB more time to ease its monetary policy, inflation should not be the ECB's main concern right now.

"Inflation can never be far from any central banker's mind, but 3% inflation, if Europe even hits that, is tolerable given the current economic situation," Affinito said. "Some economists were sort of hoping for a quick move by the ECB, but I've been in this field long enough to know that the ECB, after talks with the Fed, is probably holding off its cut for a few weeks, to provide spacing between big decisions by these two major central banks."

Central bank coordination

Affinito said he senses that the ECB, most likely in coordination with the Fed, the Bank of England, the Swiss National Bank and the Bank of Japan, have "mapped-out the monetary policy under various scenarios for the next two years, quarter-by-quarter, subject to revision, as events require."

Affinito said a substantial ECB interest rate cut immediately following Wednesday's large 75-basis-point cut by the Fed would most likely have been interpreted by business decision makers and the markets as too much monetary policy easing for one time period. Conversely, paced interest rate cuts, he said, telegraph central bank intentions, likely short-term rate conditions, and also allow business leaders to adjust their plans to be ready for the new environment. With the above in mind, Affinito fully expects the ECB to cut interest rates soon, perhaps by the end of February or in early March.

"What's involved here is not simply, 'Let's cut rates,'" he said. "It involves both preparing corporations and other institutions for the new interest rate environment, and giving them the time to do so, so that they can perform well in that new environment, for everyone's benefit."

Stimulus on many fronts

Nevertheless, Affinito underscored that as pivotal as international monetary policy is, the world's major industrialized economies "will need stimulus on many fronts" to prevent a major slowdown in global growth.

"We'll need U.S. fiscal policy stimulus, continued term auction facilities on both sides of the Atlantic to maintain short-term liquidity for key institutions, and most likely fiscal policy stimulus from the United Kingdom, Germany and France to compensate for the large economic drag caused by subprime defaults," Affinito said. "These actions will involve long-term commitments by the major nations to successfully deal with what certainly looks like the first major economic hurdle of the globalization age."