Sir:

Allow me to explain "the inexplicable" regarding the International Monetary Fund and eurozone interest rates ("Time for a hefty cut", August 4).

The problem begins with your mischaracterising both the European Central Bank's framework and our analysis, most notably when you say that we are unwilling to call for a cut until inflation is below 2 per cent. Not so. The test is what inflation will be, looking well ahead, not what it is today.

In such a forward-looking perspective, one weighs prospects for overall inflation by assessing the likely path of underlying inflation, which has been low. This path hinges in good part on growth prospects and the balance of shocks (oil prices, value added tax rate changes, and so on) likely to hit the headline rate, as well as their potential reverberations.

Three months ago we saw signals of a fading recovery, underlying inflation remaining about 1 1/2 per cent and a relative absence of shocks. The extent of domestic and international weakness, however, was still unclear. We took a wait-and-see attitude as regards immediate action but argued that the case for a cut might be materialising, notwithstanding headline inflation moving above 2 per cent.

International developments since then suggest that the worst may be over on growth but point to further upward pressure on headline inflation because of oil prices and, to a lesser extent, the exchange rate. The wait-and-see/rate-is-appropriate stance seems to have been correct if you take the ECB's inflation objective seriously.

By the same token, given present underlying inflationary pressures, we see no scope for even thinking about raising rates until a clear and firm recovery in both output and demand is in place. Indeed, we would see a case for a cut returning if signals for a faltering recovery accumulated yet again.

Finally, I do not understand your willingness to take risks on inflation for, to my mind, not well-founded hopes for a response on the reform front. Indeed, the shoe should be on the other foot.

Prompt passage and implementation of the much-maligned European Union service directive, for example, would contain prices, boost real disposable incomes and growth, and induce a more accommodative ECB stance than otherwise. That is the kind of shot in the arm that the euro area needs.