ECB paves way for rate cut despite M3 surge

The European Central Bank yesterday paved the way for a cut in interest rates tomorrow by explaining away an unexpected surge in money supply in the euro area.

The annual growth rate of M3 money supply – one of two "pillars" of ECB monetary policy – moved further away from the 4.5 per cent target, rising to 6.4 per cent in July from 6.1 per cent in June.

Economists had warned a jump in money supply could pose a last-minute hurdle to the quarter-point cut that has been widely predicted.

These concerns were allayed by the ECB, which said M3 had been "distorted". It blamed stock market weakness for stimulating demand for deposits and other securities that make up M3.

"As pointed out previously, there are indications that the data for M3 are distorted upwards," the bank said.

The euro fell to two-week lows of $0.9030, more than two cents below last week's five-month peaks, on worries the ECB would delay a rate cut.

"If I had to bet on it, I'd say they'd delay a little bit and cut in September," said Michael Schubert, an economist at Commmerzbank.

Economists who are predicting a cut in rates stuck to their guns. Ken Wattret, euroland economist at BNP Paribas in London, said the ECB would rely on the other "pillar" – economic activity.

"The bottom line is the ECB has been highlighting the distortions to M3, preparing the ground for ignoring [it] when it comes to its rate decision later this week," he said.

The ECB also highlighted a fall in M1 money supply – which mainly includes notes and coins – to 3.3 from 3.8 per cent.

But Stephen Lewis, chief economist at Monument Derivatives in London, said the ECB was open to criticism for trying to move away from a target it set only four years ago.

"The ECB probably regrets choosing the M3 definition as the first pillar of monetary policy," he said. "It is not much of a pillar if ECB policymakers have to perform contortions to find a basis for the actions they take."

Meanwhile advocates of another rate cut by the Bank of England were given fresh ammunition from a report showing the average level of pay deals had fallen to 3.2 from 3 per cent.