The European Central Bank may cut interest rates as early as next week, as the euro continues to strengthen against the dollar. The euro touched a record high against the US currency of $1.19 early yesterday and was trading later at just over $1.185.
But the strength of the euro threatens to damage already poor growth prospects for Europe and increases the risk of deflation - or falling prices - in Germany. The ECB is now under severe pressure to reduce interest rates at its monthly meeting next week, with many analysts believing that a half-point reduction is on the cards.
The euro's rise yesterday took it above its previous high of just under $1.19, reached shortly after its launch on January 4th, 1999. In the meantime it had fallen as low as 82.30 cents in October 2000.
The latest rise in the euro "could be the straw that will finally get the ECB camel moving", according to Mr Dermot O'Brien, chief economist at NCB stockbrokers in Dublin, who said a half-point (0.5 of a percentage point) cut was looking increasingly likely.
An ECB cut would knock on to lower mortgage rates for borrowers here, but would also reduce the already paltry returns to savers.
But if the ECB fails to check the rise of the euro, growth prospects for the Irish economy will be severely affected, mainly because of the impact on exporters to the US and the UK. Mr Robbie Kelleher, chief economist at Davy stockbrokers, said yesterday that the brokers' forecast of 1.5 per cent growth in the economy - as measured by Gross National Product - was now being revised downwards and was likely to be cut to zero "or as close to zero as makes no difference".
With growth prospects across the euro zone hit by the strong euro, speculation of an ECB rate cut was increased by comments from the ECB deputy president, Mr Lucas Papademos. He said that if the ECB believed it could bring euro-zone inflation down below 2 per cent in the medium term, "then it could be possible to change the stance of monetary policy to counterweight the forces that lead to a subdued economy". His comments were interpreted as meaning the bank will cut rates if inflation in the eurozone dips below 2 per cent, which is now seen as likely.
The ECB last cut its key rate - which dictates euro-zone retail rates - by a quarter of a percentage point, to 2.5 per cent, in March. The equivalent US rate is 1.25 per cent and the difference is one factor encouraging funds into euros.
The dollar has also been undermined by fears about the outlook for the US economy and concerns about the funding of its current account deficit. Investors also believe that the Bush administration is happy to see the currency slide to help revive exports and growth, while in Europe senior ECB figures have been playing down the impact of the euro's strength on the euro-zone economies.