Are the Fed and the ECB on different planets?

Yesterday, Fed Chairman Bernanke signalled a further cut in official rates on 18 March despite recent unfavourable inflation news and the 225 bp of policy stimulus already in the pipeline, not to mention a substantial expansionary fiscal package.

Meanwhile, Bundesbank President Weber poured water on hopes of a cut in ECB rates even though credit conditions are as bad in Europe as in the US and growth has moved below trend, with a risk of serious weakness in several Eurozone economies.

This policy divergence looks unsustainable. With the real Fed funds rate approaching historical post-recessionary levels, the US central bank may shift to a neutral bias after the expected March cut. Despite Weber's comments, the ECB is unlikely to reverse its recent shift to a more neutral stance at next week's meeting. Events continue to play out similarly to 2001 (see here for more), suggesting a rate cut is still plausible by mid-year.

Unsurprisingly, the dollar was a major casualty of yesterday's remarks, finally breaking below its November trough in trade-weighted terms. A sharp increase in currency volatility would be unwelcome against a background of continuing turbulence in other financial markets. Greater policy co-ordination would serve both the Fed's and the ECB's interests.