Time for central bank to take a breather

If you want to know what is happening in the world economy just now you have to look across the Atlantic.

Although US share prices hit an all time high last week it is not a pretty picture. Quarterly economic growth has more than halved to around 2% this year. Federal Reserve Board Chairman Ben Bernanke, America’s top economic policymaker and a staunch supporter of Republican President George W. Bush, has confessed, just weeks before elections which could give the Democrats control of Congress, that the housing bubble has burst and the market is facing "a substantial correction".

But what does this mean for Europe? Are we looking at another asset price driven slump like the hi-tech dot-com crash of 2001? If so will Europe be dragged down again in its wake?

It depends in part on how bad things get in America. Credit rating agency Moody’s, which has surveyed almost 400 US metropolitan areas, predicts a housing market crash in twenty of them. This is serious because consumer borrowing against the soaring values of homes - so-called mortgage equity withdrawal - has kept the US economy roaring ahead in the past three years. A house-price plunge could halt this borrowing and spending spree.

Europe could not, of course, escape a US slowdown entirely. But this does not mean that a repeat of 2001-2, when the euro area followed the US to the brink of recession, is inevitable.

Certainly the transatlantic economies are more closely linked than ever before. As usual, if the US slows, EU trade will be hit. But this is no longer the most important facet of the economic linkages. Trade flows are not that big.

What we learnt in 2001-2, however, is that the billions of dollars which European companies have invested in American operations mean that what happens in America can have a big impact on their balance sheets, and on their behaviour. The huge losses which, for example, DaimlerChrysler’s unit in Detroit is now suffering, will appear as red ink in the German group’s accounts and make it more cautious.

Financial market links are deeper too. If shares on Wall Street slump as business profits and confidence fade, it is hard for European share prices to buck this trend.

But, provided that there is no dollar crisis, it may be a mistake to assume a repeat of 2001-2 is looming. First, that shock to the world’s economies was synchronised. The bursting of the dot.com bubble hit them at the same time. The 9/11 terrorist attack, too, was a one-off event which dented global confidence. Oil prices rose for everybody - admittedly nothing like as dramatically as in the past two years.

Today, Asian export markets still look strong. Some European economies seem in better shape. You do not have to agree with Stephen Roach, chief economist with US investment bank Morgan Stanley, about the new Wirtschaftswunder or economic miracle, in Germany. Nevertheless, a country which accounts for close to a third of eurozone output, may, at last, be emerging from its post-reunification doldrums. Next year’s VAT increase will be a test. But the recent trend-setting wage increase agreement of 3.7% in the German engineering industry is, finally, going to inject some spending power into German consumers’ pockets.

Much depends on how Washington reacts. With inflation running at 4% there are limits to how far the Fed can cut interest rates this time around. Now, however, is as good a time as any for the European Central Bank to take a breather. After last week’s interest rate increase to 3.25%, it should stay vigilant, but sit on its hands - at least until next year.

• Stewart Fleming is a freelance journalist based in Brussels.

If you want to know what is happening in the world economy just now you have to look across the Atlantic.