Opinion: European Central Bank Interest Cut was Overdue

The European Central Bank made a long overdue decision, a necessary decision, by cutting its main interest rate to 2.00 percent on Thursday. The general economic forecast had been calling for the reduction for some time. The bank’s highest priority -- price stability in the euro zone -- had already been achieved, and the yearly inflation rate had dropped to 1.9 percent in May, below the critical two-percent mark the ECB had set as its goal.

And all signs show that the inflation rate in euroland will stay under two percent. The weak economy will ensure that. In times of decreased demand, price increases are hardly possible. The strong euro also plays a role in reducing inflation by making it cheaper for European industry to buy natural resources and energy.

The economic environment was already ripe for an interest rate cut. There was enough playing room for such a move; any other action would have triggered immeasurable disappointment on the world financial markets.

Frankfurt's moody diva

But the European Central Bank is something of a moody diva who doesn’t appreciate it when politicians demand things from it. After all, it is -- like its role model, the Deutsche Bundesbank -- an independent institution, which makes its own independent monetary and currency decisions.

Over the last few days there certainly was enough pressure on the bank to play its part in spurring economic growth -- most recently from politicians at the G8 summit in Evian and from the International Monetary Fund. They all more or less directly demanded the ECB cut interest rates in light of the low inflationary risk. But one has to tred lightly, as the bank could just as easily have decided to postpone lowering rates to spite the politicians.

Getting the ball rolling

As it is, the markets have gotten what they wanted. The ball is, so to say, back on the playing field. Banks can refinance themselves more easily. The economy has more money at its disposal for investment, and consumers may even receive more affordable credit rates. At the same time, the ECB has reduced the interest rate gap between Europe and the United States. The low interest rate in the U.S. -- compared to that in Europe -- was partly to blame for the euro’s sharp climb in the last few weeks.

The ECB interest rate cut also puts to rest the looming fear of deflation. For the time being, the prospect of falling prices and an economic downward spiral should be out of the picture.

Now that the ball is back on the field, it’s up to the economy to pick it up and kick off. The ECB may have created a better environment for economic growth, but it alone cannot rev up the economy, it alone cannot create more jobs. That is something investors and consumers must do on their part -- through more consumption, more investment and more confidence.