ECB cuts rates amid economic woes

THE European Central Bank cut its benchmark interest rate by 50 basis points to two per cent yesterday, matching its lowest-ever rate as inflation plummets and recession spreads.

The cut, in line with consensus forecasts, marks the fourth cut in just over three months amidst signs the financial crisis is biting hard into the real economy and inflation threatens to fall further below the ECB’s two per cent ceiling.
The majority of economists in a Reuters poll had expected the ECB to take another 50 basis points from benchmark credit costs, although the level of uncertainty around the decision was unusually high.
Economists said the cut would not likely be the last, but the ECB might pause before the next move.
‘There may be a pause or smaller cut in February, but it will all depend on the data flow,’ Dresdner Kleinwort economist Rainer Guntermann said.
‘If we get more significant disappointments coming through, the market will continue to look for further rate cuts.’
Before the decision, some analysts had forecast the ECB would leave rates on hold and others had expected a smaller, 25 basis point, move. Financial markets had priced in 50 basis points or more.
The euro fell to a 5-week low against the US dollar after the decision and a 6-week low against the yen, while Bund and Euribor futures rose.
Trichet justified the rate cut by pointing to the diminishing upside risks to inflation, which fell to 1,6 per cent in December, and a contraction in domestic demand as well as tighter financing conditions. The ECB also set new rates for its overnight facilities, after announcing in December it would increase the gap between these rates and the benchmark rate to back to 100 basis points. From January 21, funds borrowed from its marginal lending facility will attract an interest rate of 3 per cent and overnight deposits will pay one per cent.
Inflation in the euro zone has fallen rapidly in recent months and was 1,6 percent in December, compared with the ECB’s goal of keeping inflation below, but close to two percent. Economists expect inflation to fall further and some of them have warned of deflation danger, as falling prices could make already cautious consumers even more jittery and cut spending.
While rates at two per cent match the lowest level in the 10-year history of the ECB in historic terms, they pale alongside almost-zero borrowing costs in the United States and Japan, as well as a British central bank thought to be headed in a similar direction.
The numbers on the euro zone have got worse by the week since the bloc was confirmed as in recession late last year. Recent data showed Germany’s economy, the euro zone’s biggest, likely shrank 1,5-2 per cent in the fourth quarter of 2008 and officials there have signalled this year will see the worst contraction since World War II.
Industrial production has also plummeted across the 16-country bloc in recent months. – Nampa-Reuters