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The European Central Bank is set to keep euro zone interest rates at 4 per cent on Thursday despite growing calls for it to cut borrowing costs and join efforts to avert a worldwide economic downturn.
The ECB has so far resisted following the United States, Canada and Britain in reducing official rates because of high inflation in the 15 countries using the euro.
While euro zone inflation hit a record high in January, signs of faltering growth in Spain, Italy and elsewhere in the bloc are expected to weigh on the ECB Governing Council, which started its monthly rate meeting at 0800 GMT.
Economists will pay close attention to whether the ECB emphasises risks to growth once it has announced its interest rate decision at 1245 GMT. They will listen carefully for any toning down of President Jean-Claude Trichet's anti-inflation rhetoric during a news conference at 1330 GMT.
"It is too early to think they will surrender and actually start cutting rates," said UniCredit economist Marco Kramer. "The ECB can quickly become more pragmatic and not ignore inflation risks but stop talking in a hawkish manner."
All 83 economists polled by Reuters last week said they thought the ECB would leave rates unchanged on Thursday. But most foresaw rates falling to 3.75 per cent by the end of June and to 3.5 per cent by end-2008.
Futures traders have taken a more aggressive stance, betting on three cuts this year, with the first as early as April. Markets show a one-in-five chance that the ECB will start its rate-cutting cycle as early as next month amid continued investor uncertainty on the fallout from US subprime problems.
In a reassuring sign, Germany's flagship Deutsche Bank AG stood by its promise of no more subprime surprises for investors with only small writedowns for the final quarter of 2007 on Thursday.
But US banks have fared worse and the U.S. Federal Reserve has slashed its benchmark rate by 1.25 percentage points since the last ECB meeting, when Trichet said officials discussed the possibility of needing to raise rates to thwart inflation.
Such divergence between the world's two largest central banks is not expected to persist, particularly due to increasing political and industry pressure on the ECB to bend.
Necessary Policy Measures
French Trade Minister Herve Novelli said on Thursday the strong euro was hurting exports. The International Trade Union Confederation urged the ECB this week to follow the Fed in using "the necessary policy measures" to offset looming economic slowdown.
US Treasury Undersecretary David McCormick, speaking before a weekend meeting of the Group of Seven (G7) rich nations in Tokyo, said other countries needed to take steps to boost their growth to buoy the global economy.
The Fed's cuts and the ECB's tendency to keep rates steady have kept the euro close to record highs near $1.50 against the US dollar, making euro-zone goods more expensive abroad and dragging down growth in some places.
Spain, where growth was long fuelled by a hot housing market, looks particularly shaky, with consumer confidence at a record low and both industrial output and service activity anaemic. Growth has also cooled in Italy and Portugal, and the European Commission's economic sentiment is at its weakest since early 2006.
BNP Paribas economist Luigi Speranza said a sharp deceleration in euro zone services activity had added to fears that Europe's economy has already started to falter. "The economy is losing momentum even before we see the full impact of a US downturn," he said.
Several members of the ECB's Governing Council have expressed doubts over whether the euro zone economy will grow at the pace of around 2 per cent which ECB staff predicted in December. Updated forecasts are due in March.
But others suggested concerns about a surprisingly weak services Purchasing Managers' Index would not sway the ECB from its current, cautious, course. "It is a bit of a warning signal, but I'm not sure if it really tips the balance for a significantly different message," Dresdner Kleinwort economist Rainer Guntermann said. (Reuters)
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