Central banks poles apart on interest rates

FRANKFURT/WASHINGTON (Reuters) - Leading central banks which have pulled together to tackle the global credit crunch over the past six months have shown far less coordination over monetary policy.

Central banks of the United States, Europe and Japan jealously guard their own turf, setting or adjusting interest rates with a view to conditions in their domestic economies.

Some analysts believe the disconnect between action by the U.S. Federal Reserve, which has aggressively cut key interest rates to thwart recession, and the European Central Bank, which has held rates steady as a bulwark against high inflation, is a recipe for volatility in increasingly interconnected financial markets.

The Fed's cuts and the ECB's steadfastness are keeping the euro close to record highs near $1.50 against the U.S. dollar and investors are braced for a rough ride if the rate gap between the world's two biggest economic regions widens further.

"It doesn't help when two of the world's key central banks are off beam in opposite ways," said London School of Economics professor Willem Buiter, a former Bank of England policymaker.

The Fed and the ECB's diverging paths on interest rates are in contrast to increasing cooperation over the last six months as the crisis in U.S. subprime mortgages roiled global markets.

Although the Fed was slower to inject liquidity than the ECB as the first subprime shockwaves spread last August, it moved later to update its monetary arsenal.

In December, the U.S. central bank launched a temporary short-term lending facility aimed at easing credit market strains and joined with the ECB and the central banks of Canada, England and Switzerland to provide markets with additional cash.

Dutch central bank chief Nout Wellink, a 25-year central bank veteran who chairs an international bank supervision committee, said this week that cooperation was deeper now than after the September 11, 2001 attacks, when central banks also acted together to provide liquidity to markets.

"I have seen more cooperation recently between the Fed and the ECB than I have seen in all the years that I have been in this profession, more cooperation than after 9/11," he said.

Central bankers including ECB President Jean-Claude Trichet and Fed Chairman Ben Bernanke increasingly use scheduled Bank for International Settlements meetings or other diplomatic gatherings to share information and, in some instances, lay groundwork for coordinated action.

"(Central banks) have probably over time shifted to more regular communication," former Fed staffer Vincent Reinhart said. "A main advantage ... is they also get to know their counterpart when they do have to pick up the phone."

Failing to pick up the phone has brought French central bank chief Christian Noyer into the spotlight in the last week. Noyer did not inform other central banks or his government about problems at France's Societe Generale until the bank had unwound 50 billion euros ($74.35 billion) in unauthorized deals blamed on a rogue trader.

The news came too late for the Fed, which cut rates in an emergency move the day before after a sell-off in global equities, not helped by SocGen's actions.

But central bank insiders say there are no hard and fast rules on information sharing, and Noyer's silence was a judgment call rather than a communications breakdown.

DIFFERENT STROKES, DIFFERENT FOLKS

Economists say the contrasting monetary policy tactics deployed by the Fed and the ECB to address the fallout from exposure to the U.S. housing slide and the credit crunch reflect the two institutions' differing approaches.

"They are acting very differently but that is not a communications problem, they just disagree," LSE's Buiter said.

"They have different problems, different views on where their economies are going, and different views on how to manage monetary policy. They really are different beasts."

The Fed has trimmed rates five times since mid-September, taking the benchmark fed funds rate from 5.25 percent to 3 percent, and left the door open to more rate reductions.

The ECB has held rates steady at 4 percent since June, citing inflation fears, although analysts expect it will have to cut rates in the second half of the year.

This is in line with historical trends showing that ECB interest rate cycles tend to lag the Fed, and that U.S. rates tend to move in a wider range than euro zone rates.

In its 9-year history the ECB has changed interest rates 23 times, while the Fed has moved 42 times over the same period. The easing cycle which both began in 2001 chopped 5.5 percentage points off U.S. rates in 13 steps, compared to seven steps totaling 2.75 percentage points in the euro zone.

In a speech in 2006, Trichet denied this showed the ECB was passive, pointing to fundamental economic differences: U.S. prices and wages, for example, rise more quickly in response to accelerating growth and require a forceful response, while reaction times in the euro zone are more sluggish.

Another difference is the role played by financial markets, which loom larger on the Fed's horizon than on the ECB's.

"In the U.S. the financial markets have a greater impact on people's lives than they do in Europe," University of Frankfurt professor Stefan Gerlach said. "In Germany for example people rent. In the U.S. they buy."

Former Fed Governor Susan Bies said different institutional objectives also played a role, a point also made by Wellink.

The Fed has a double focus of maximum employment and stable prices, while the ECB has its sights fixed on inflation and only when prices are guarantee does the focus turn to growth.

(Editing by David Christian-Edwards)