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What's Wrong With Europe's Central Bank?

by Dennis Jacobe, PhD
Chief Economist, The Gallup Organization

The day after the U.S. midterm elections, the Federal Open Market Committee (FOMC) lowered interest rates 50 basis points. Obviously, the Fed experienced an epiphany last week and now recognizes that the U.S. economy is much weaker than many economic prognosticators have been maintaining. Unfortunately, neither the European Central Bank (ECB) nor the Bank of England followed the Fed's lead, and decided to leave European interest rates unchanged. Apparently, European monetary policy-makers have not shared in the Fed's recognition of today's economic reality and the need to provide immediate stimulus to the world economy.

EU5 Investors Are Pessimistic

In October, European investor sentiment became increasingly pessimistic, according to the Index of Investor Optimism -- EU5 -- a joint effort of UBS and The Gallup Organization. The EU5 Index is now at -33 -- down nine points from -24 in September. In August, the Index was essentially neutral at -1. The October reading is the EU5 Index's most negative measurement since its baseline was established in October 2001 at 4.

While the overall EU5 Index became even more negative (net pessimistic) in October, the Personal Dimension of the Index remained marginally positive at 6, although this dimension also decreased three points. The Personal Dimension, which tracks investors' feelings about their personal financial situations, hit its 10-month high in January at 44. It had declined to 18 by August and fell another nine points in September to 9. From an economic outlook perspective, this is the most positive aspect of the September and October survey results.

On the other hand, the Economic Dimension of the EU5 Index is the reason EU5 investor sentiment was net pessimistic for October. This dimension declined six points in October to -39, following its 14-point plunge to -33 in September. European investor sentiment toward the economy is now more negative than it was about a year ago, when investors rated this dimension at a -29.

EU5 Investors Are Concerned About War

Nearly half of EU5 investors (47%) say that a war with Iraq is the most important threat to the global stock markets over the coming year. Another 19% say that the most important threat is major terrorist attacks, while 18% point to a prolonged economic downturn. The percentage pointing to further business accounting scandals has fallen to 11%, while a financial crisis in Latin America is singled out by only 3%.

About half of European investors (55%) say they expect a U.S.-led military attack against Iraq within the next six months. Three in four EU5 investors (74%) say that a war against Iraq would have an extremely negative (38%) or somewhat negative (36%) impact on the global stock markets.

Key Points

For those of us monitoring public opinion, the Fed's recent action reaffirms our view that the United States is headed for a weak holiday sales season and an even weaker economy during the first quarter of 2003. At the same time, the Fed's action provides us with some reassurance that U.S. monetary policy-makers recognize the risks associated with the current economic situation, and are willing to act to stimulate the economy when necessary.

Given this context, it is hard to understand the inaction of the ECB. Surely European monetary authorities do not believe that the economy in Europe is going to get stronger as the U.S. economy weakens. Further, it is clear that the geopolitical situation -- with the potential for war with Iraq and the fear of additional terrorist attacks -- is an even greater drag on investor optimism in Europe than it is in the United States. The U.S. elections suggest that, if anything, President George W. Bush is in a stronger position to pursue his international policies, including a war with Iraq.

In sum, it appears that the increasing investor pessimism in Europe is warranted given the condition of the world's economy and the policies of the ECB. At this point, we can only hope that Fed officials have some serious conversations with their ECB counterparts in the next few weeks concerning investor confidence and the weakening world economy. Perhaps ECB officials can be convinced that given the current pessimism of European investors, the ECB should ease interest rates and join the Fed in trying to get a real worldwide economic recovery underway by mid-2003.

*Results for the Index of Investor Optimism -- EU5 are based on interviews with approximately 200 investors each in France, Germany, Great Britain, Italy, and Spain conducted October 1 to 16, 2002. For results based on a total sample of approximately 1,000 investors, one can say with 95% confidence that the margin of sampling error is ±3%. In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls.


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