The transatlantic response to America?s financial semi-seizure might be coming slowly into focus. There is now a clear acknowledgement among policymakers in Europe that it faces a slowdown. This indicates an erosion of the ?decoupling? thesis as far as the UK and eurozone go. On Thursday, the Bank of England (BoE) cut its key interest rate by 25 basis points to 5.25% and issued a statement on balancing concerns of growth with inflation. This was followed by an announcement by the European Central Bank (ECB) that its key rate would stay unchanged at 4%, though its bias had shifted towards a rate cut, as opposed to a possible rate hike signalled barely a month ago. Eurozone inflation, estimated at 3.2%, reigns dangerously above its 2% tolerance limit. The ECB, while cautioning European governments against any fiscal loosening, also announced a couple of more liquidity injection packages of euro 60 billion each for money markets. The BoE?s rate cut had been ?priced in? by global markets, but the ECB?s no-cut was a surprise, resulting awkwardly in a decline in the euro?perhaps on market expectations that waiting longer to loosen money would make a sharper cut inevitable later in the year, or even accentuate the risk of a hard landing. But with inflation-targeting a crucial part of its mandate, the ECB?s balance of choices is constrained. It was hard enough getting the fiscal and monetary policies of so many countries in rhythm to converge towards a common currency, and success of the euro project still hinges on monetary policy anchoring inflationary expectations for all. Which would mean prioritising price stability over GDP growth.
That, however, does little to lift the market gloom hovering over the continent. Like the US, it could soon have its first brush in a long time with stagflationary trends, which would put both fiscal and monetary policy in a spot. This might test the capacity for policy coordination among EU members yet again. Larger questions of whether the recent boom was an artificial one, engineered by policy interventions designed to delay a bust, are likely to surface with increased vigour. Notably, Europe has always been more susceptible to scepticism on market mechanisms. But it is also somewhat better placed to address the origins of some of its woes. Some hard thinking is in order.