Euro falls amid sign ECB is retreating on rates

The euro slid sharply yesterday after signs that the European Central Bank had become less upbeat about eurozone growth prospects were interpreted as reducing the chances of it making good its threats to raise interest rates.

Yves Mersch, Luxembourg's central bank governor who sits on the ECB's governing council, said the central bank should "be cautious" amid the widespread economic uncertainty and hinted that eurozone growth forecasts might soon have to be revised downwards.

Although Mr Mersch represents one of the eurozone's smallest member states he is regarded as among the more "hawkish" members of the 21-strong ECB council, and his comments in an interview with Bloomberg suggested some of its members at least were moderating their tone.

Earlier, Axel Weber, Germany's Bundesbank president, also appeared to be hedging his usually hawkish stance when he acknowledged that German inflation could have eased significantly by 2009.

Eurozone inflation was yesterday confirmed at 3.1 per cent, way beyond the ECB's target range of a rate "below but close" to 2 per cent.

However, the latest comments did not mark a fundamental change in the stance of the ECB, which had long assumed eurozone growth will moderate this year, but not dramatically.

The ECB's latest forecasts, released in December, foresaw growth of around 2 per cent this year, after about 2.6 per cent in 2007.

At the same time, the ECB remains concerned that higher wage demands could fuel longer term inflationary pressures.

Last week, Jean-Claude Trichet, the ECB president, warned he was prepared to act "pre-emptively" to prevent such "second round" effects - a stance that appears unlikely to change while crucial wages negotiations continue in Germany.

But financial markets treated Mr Trichet's comments hinting at possible interest rate increase with scepticism - especially with the US Federal Reserve preparing for cuts in US borrowing costs.

Instead, analysts believed increasingly that the next move in ECB interest rates would also be downwards.

"What probably has happened is that there has been a general feeling around in the investment community that the ECB was likely to cut rates this year, but that wasn't actually really priced into markets," said Julian Callow, economist at Barclays Capital.

Last night Mr Trichetsaid the central bank's position had not changed since last week.

"We explained it last week. The statement of the governing council is still valid," he said.