ECB moves to quell City's growing fears

THE PRESIDENT of the European Central Bank is to step up his campaign to convince the markets of his credibility, amid the City's growing fears that leading European politicians could undermine the Bank's tough anti- inflationary stance.

Wim Duisenberg, ECB president, will this week explicitly reject calls for the Bank to target exchange rate stability as well as price stability - a proposal favoured by Oskar Lafontaine, the new German finance minister, who has angered bankers with his repeated calls for cuts in European interest rates.

In an article to be published in Brussels-based newspaper European Voice, Mr Duisenberg will say that so-called "target zones" - which would set exchange rate bands for the euro and other key world currencies such as the dollar - are inconsistent with controlling inflation.

Mr Duisenberg is expected to use a keynote speech in London later this week to assure the markets of the ECB's independence. Next week's meeting of the ECB ruling council is also being seen as an opportunity to boost the Bank's credibility ahead of the launch of the euro in just over a month's time.

The run-up to the euro's launch was always going to be a critical time for the new ECB, which needs to have the confidence of the markets if it is to be able to pursue successfully a tough anti-inflationary line.

However, recent statements by key European policymakers, in particular by Germany's Mr Lafontaine, have heightened fears in the markets that the ECB will not be completely free of political interference.

The leading investment bank Nomura, in a recent bulletin, argued: "There are worrying signs that the governments in Europe will try to influence the independent ECB."

Market concerns about the ECB's independence fall into three key areas. First, there is the concern that the ECB will give into politicians' calls for target zones, a move that most economists believe will compromise the Bank's goal of price stability. "Substituting exchange rate stability for the goals of economic and price stabilisation would risk increased volatility of output and prices," warns Salomon Smith Barney.

The second concern is that European governments could jeopardise the ECB's aim of price stability by violating the spirit - although perhaps not the letter - of the Fiscal Stability Pact. The pact imposes strict limits on government borrowing in an attempt to ensure that the more profligate European governments do not undermine the stability of the euro.

However, recent indications are that policymakers will interpret the pact more loosely than initially envisaged. For example, Mario Monti, the EU single market commissioner, recently proposed the introduction of a "golden rule" into the pact. Such a move would approve borrowing earmarked for capital investment.

"We cannot totally rule out some watering down and increased flexibility of interpretation [of the pact]", say economists at Bank of America.

Finally, there are fears that key European policymakers will try to appoint like-minded people on to the ECB governing council, thus undermining the euro by the back door.

Market attention is now focused on potential candidates for the presidency of the German Bundesbank. Hans Tietmeyer, the current president, is due to retire in August and there are fears the government will attempt to replace him with someone more "Mr Lafontaine-friendly". This, some say, represents the greatest threat to the ECB's independence in the coming months.