Europe Slams the Door On Interest-Rate Cuts

European Central Bank President Jean-Claude Trichet appeared to slam the door on an interest rate cut, contributing to another round of selling in global stock markets and prompting second-guessing among market watchers.

AP European Central Bank President Jean-Claude Trichet

Trichet’s signal came amid growing hopes that central banks around the globe would follow up on the Fed’s three-quarter of a percent cut in the fed funds rate Tuesday to help calm equity markets and jumpstart growth amid a growing sense of dread about a US recession.

Instead, Trichet emphasized the need to fight inflation, saying "In demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility in already highly volatile markets."

Market watchers were surprised by the bluntness of the statement.

"I would have left myself more room, been a bit slightly more opaque, allowed for more flexibility," said money manager Jim Awad,  chairman of of W.P. Stewart Asset Management. "I think they’re wrong and behind the curve and I think they’ll wind up doing a U-turn just like Bernanke did."

Though the ECB has traditionally put inflation fighting ahead of growth generation, economists also questioned the wisdom of Trichet's wisdom given the current market environment.

"Trichet seems to have made a great flourish on how the right thing to do is to do nothing," said Robert Brusca, chief economist at FAO Economics, adding that a cut would be "uncharacteristic, but on the other had you do what the times demand."

In testimony to the European Parliament, Trichet stuck to the ECB’s forecast for 2008 GDP growth of 2 percent and did not comment on the Fed’s decision, but economists say any US slowdown – regardless of whether it is an actual recession – will cut growth in Europe, mainly through lower exports.

Merrill Lynch underscored growing concerns about the US economy by halving its forecast for 2008 GDP growth to 0.8 percent. Merrill and Goldman Sachs are both calling for a recession this year. Other economists, however, say it is still too soon to tell.

Other market watchers downplayed the overall impact of the Trichet statement.

Terri Campbell, Managing Director, Eastern Investment Advisors, told CNBC that the ECB has behaved "this way before", adding her firm "expects an ECB rate cut sometime soon."

Campbell said that Germany – the largest member of the Euro zone group –

will pressure the ECB for a rate cut given the importance of its export sector.

Both the ECB and the Bank of England next meet on Feb. 9, more than a week after the Fed’s next regularly scheduled FOMC meeting on Jan. 29-30, where the US central bank is widely expected to cut rates again, with economists looking for a reduction of 25 to 50 basis points.

Given a similar though milder slump in the real estate market in Britain, economists expect the BOE to cut rates, having trimmed them at its last meeting.

"We think they’re going to cut again but they have to be careful," said Brusca, explaining that the BOE must also be careful not to damage its inflation credentials, especially since its labor market remains relatively strong.

The absence of any immediate rate cuts from central banks in Europe and Japan added another dimension to the already significant speculation about Fed policy.

There are several camps – one says the Fed is guilty of a too-little-too-late approach, another says the the credit crunch is so entrenched in the US economy that there’s little the Fed can do to avert a recession, while still another says Fed Chairman Ben Bernanke has changed his thinking and thus policy inclination.

"Is Bernanke the long distance runner or the sprinter," asks Ann Gulotta, VP at Northern Trust. Gulotta said Bernake had "a long-term view on how to create stability, Now he’s really stepping up."

Gulotta is among those who say the slowdown has moved from the financial sector to the consumer sector as well, which makes a slowdown more dangerous.

Bruce says the temporary Fed-ECB-BOE-Bank of Japan disconnect has greater implications.

"Are the Europeans too hard headed or did the Fed panic?" asks Brusca.

"I think the financial markets will force the hands of central banks overseas," says Awad, as if answering the question.

That question may be answered with greater certainty in the weeks to come, but in the meantime, investors will decide that on a day-to-day basis.