ECB to announce unprecedented third interest rate cut

The European Central Bank is set to announce on Thursday an unprecedented 75 point interest rate cut. Confronted with a full-blown recession and a free-fall inflation, the Eurozone has cut its rate for the third time since Oct. 8.


(AFP) - The eurozone is set for an unprecedented third interest rate cut in less than two months when European Central Bank governors meet this week in Brussels, with the key question being, by how much?

With the eurozone in a full-blown recession and inflation in a free-fall, analysts say the ECB has plenty of leeway to reduce the cost of borrowing in what will be 16 nations when Slovakia joins in January.

"The case for a rate cut of more than the customary 50 basis points (0.50 percentage points) has never been stronger," said Bank of America economist Holger Schmieding last week.

"In fact, we find it difficult to see any convincing argument against cutting rates by at least 75 basis points," he added, an amount the ECB has never chosen before, though it was discussed last month.

"Leading economic indicators are plunging at a record pace, inflation is tumbling and unemployment is soaring in the eurozone," Schmeiding noted.

Markets were disappointed when the ECB reduced its benchmark rate by 0.50 percentage points to 3.25 percent in early November after the Bank of England unveiled a shock cut three times bigger.

Both had joined the US Federal Reserve and three other central banks in a coordinated 50 basis-point cut on October 8.

Inflation, which the ECB has pledged to keep under control, plunged in November to a 14-month low as oil prices collapsed, an official EU estimate showed on Friday.

Inflation dropped to 2.1 percent from 3.2 percent in October, the Eurostat data agency said, paving the way for deeper interest rate cuts.

But several ECB directors stressed recently it would be unwise to use up rate-cut ammunition too soon and that a dramatic cut by the cautious bank could spread fear in markets that the situation was worse than believed.

That said, ECB president Jean-Claude Trichet removed any doubt that lower rates were in the cards on Wednesday, saying in Cairo: "We are ready to cut interest rates."

On Thursday, a 27-nation EU survey showed that European Union consumer and business confidence slumped in November to the lowest level in 23 years.

And eurozone unemployment nudged higher in October to 7.7 percent -- the highest in nearly two years, Eurostat said on Friday.

An EU economic stimulus package unveiled two days earlier worth around 200 billion euros was dismissed by UniCredit Markets economist Marco Annunziata as "more of a publicity stunt than anything else."

Fresh ECB staff forecasts for eurozone growth are also to be released Thursday, along with estimates for inflation which hit a record 4.0 percent in July but is now falling so fast that some have begun to talk of deflation.

"The debate on whether the eurozone may experience a deflationary spiral next year has recently stepped up," UniCredit's Aurelio Maccario said.

While the ECB position is that it is unlikely, the bank is leaving itself room for maneouvre by lowering rates in incremental steps.

Governing council member Ewald Nowotny, among others, "has argued that the ECB should be 'cautious' and hold back some 'firepower' for now," Capital Economics economist Jennifer McKeown noted.

She expected the ECB forecasts to "reveal marked downward revisions to the projections for both growth and inflation."

Trichet might even acknowledge the eurozone economy could contract next year after already shrinking in the second and third quarters of 2008 to meet the technical definition of recession.

But he could also call on governments to use measures at their disposal to counter what looks like a landmark recession and will likely urge commercial banks again to quickly relay previous rate cuts to businesses and households.

Chronic fears among banks over potentially massive losses linked to the financial crisis have frozen interbank markets that are crucial conduits for supplying economies with the credit they need.

And even drastic cuts would have little effect if those financial bloodlines remain clogged.

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