The European Central Bank Thursday kept its key, short-term interest rate the same at 1%, a move investors in Europe and around the world no-doubt welcomed, for several reasons.

First, Europe's economy is nowhere near sustainable growth status: euro-zone GDP will likely to show a 3.7-4.0% contraction in 2009, and post only a modest increase in 2010 -- perhaps as low as 0.5-1.0% GDP growth. ECB President Jean-Claude Trichet underscored as much. "We know we have a bumpy road ahead of us," Trichet said, Reuters reported Thursday.

European Central Bank President Jean-Claude Trichet jolted the markets Friday with the announcement that the ECB will gradually withdraw the emergency cash injections it has added to the financial system, in order to prevent an acceleration in inflation.

"Not all our liquidity measures will be needed to the same extent as in the past," Trichet said at a conference in Frankfurt Friday, Bloomberg News reported. "Any non-standard measure whose continuation would pose a threat to the achievement of price stability must be undone promptly and unequivocally."

Seems Wall Street will not be able to extend Wednesday's gains as U.S. stock futures are quite a bit lower this morning, indicating resumption of the selloff is ahead. If on Wednesday investors hoped China would announce more spending, today they were disappointed when China's premier didn't announce more stimulus. In addition, auditors raised doubts about General Motors (NYSE: GM) viability.

Overseas, European markets dropped Thursday after the previous session's strong rally, as investors await key interest rate decisions later in the day by the European Central Bank and the Bank of England. So far, the BOE has cut the benchmark interest rate to 0.5%, the lowest since the bank was founded in 1694. The ECB is also expected to cut rates.

The dollar plunged to a two-year low versus Japan's yen Tuesday, and retreated against other major currencies, on fears the U.S. economy has fallen into a recession, Bloomberg News reported.

The dollar fell 1.26 yen to 106.90 versus the yen. Meanwhile, the British pound rose about 1.5 cents to $1.9704 in mid-day Tuesday trading. The dollar was virtually unchanged versus the euro at $1.4862.

Economists and analysts say a recession in the United States would invariably drive the dollar lower, due to foreign investors' reduced demand for dollar-denominated U.S assets, many of which would underperform during a recession. The dollar also would be hurt by lower interest rates, a near-certainty in the months ahead, with the U.S. Federal Reserve widely expected to again cut benchmark, short-term interest rates to jump start the U.S. economy.

The ever-prescient Financial Times columnist Martin Wolf, an economist, raises, and to some degree answers, a question that no-doubt has been on the minds of U.S. investors, readers, as well as Europeans: Why does banking generate such turmoil?

Or, as Wolf put it another way: why is banking an accident waiting to happen, with the crisis in securitized lending the latest example?

The answer - - or fault, to paraphrase Shakespeare - - lies within ourselves, Wolf argues, due to the very things nations have established to protect depositors - - namely, depositors' insurance and government guarantees, which prompts banks to take high risks.

No one ever said serving on the U.S. Federal Reserve Board of Governors was easy. Next Wednesday's Fed meeting may provide a case study regarding just how difficult that job is.

The FOMC, led by Chairman Ben Bernanke, will be asked once again to address the health of the U.S. economy amid two contrasting views of reality. To be sure, different interpretations regarding the U.S. economy is not something the Fed has never encountered: they're the essence of the arena of ideas that flourish in a free society, and part of what makes a market "a market."

The Fed, it seems, is perpetually trying to sift through the arguments (and data) of those who believe inflation is too high and those who believe the U.S. economy is growing too slowly.

Further, setting the appropriate policy would be somewhat easier if the Fed knew that only domestic factors determined either economic condition. But the Fed knows that is not likely the case.

One example: The Fed lowers short-term interest rates, as it did a month ago, to begin to stimulate the slowing U.S. economy, only to find that its counterpart, and the world's second most important central bank, the European Central Bank, is not. Of course, it's clear that the ECB is undertaking the monetary policy appropriate for the euro zone, but it's also clear that the policy hurts the U.S. economy's ability to grow at a time when the Fed is undertaking a policy to achieve that goal.

Another example: Conversely, when the Fed maintains short-term interest rates, as it did last year and early this year to control inflation, China, Asia, and most other emerging market economies continued to increase oil consumption -- a condition that helped push oil above $85 per barrel -- a major contributor to U.S. inflation. True, U.S. oil consumption is per capita the highest in the world, but few would deny that, along with U.S. demand, emerging/international market oil demand is stoking both oil's price and U.S. inflation. In other words, it hurt the Fed's inflation control effort previously, and it's hurting it today.

Fed Analysis: Given current conditions, it's likely the Fed on Wednesday will lower the federal funds rate by another quarter percentage point, to 4.50% from 4.75%. In September, the FOMC surprised most in the financial markets by lowering by one-half percentage point its key lending rate, to 4.75% from 5.25%, the first rate decrease in more than four years.

The monetary policy easing is expected to provide domestic stimulus to help recharge the U.S. economy while not re-stoking domestic inflationary pressures, qualified by the fact that international factors may hinder the Fed's goal.