ECB likely to slash interest rates in March, says Almunia

The European Central Bank is likely to cut interest rates in March, European Commissioner for Economic and Monetary Affairs Joaquin Almunia said yesterday.

The ECB has cut its key rate to two per cent from 4.25 per cent since October. Economists expect a further cut to 1.5 per cent in March.

"Monetary policy should be expansionary," Almunia told an economic conference in Brussels.

Almunia said that even with expansionary monetary policy and fiscal stimulus packages, financial markets have not recovered.

"Credit is very weak," he said, though there are some signs of stability, he added.

"The possibility of a big meltdown of the financial system isn't there," Almunia said, adding that governments will not allow big banks to fail the way Lehman Brothers did in September.

Almunia outlined risks to the European Union's economic outlook, including the possibility of deflation in some EU states.

"We are in a very uncertain scenario," he said.

Meanwhile, the European bond prices show that the European Central Bank President Jean-Claude Trichet's decision to keep interest rates unchanged earlier this month will push the region's economy deeper into recession. The European Central Bank President said that following the Federal Reserve and Bank of Japan in cutting rates to near zero has "drawbacks" that are "inappropriate". Even so, investors drove yields on two-year German bunds to the lowest level relative to longer-maturity debt since 1997 in a sign that they are betting he will have to do just that.

"The bond market is telling the ECB they need to wake up to reality," said Komal Sri-Kumar, chief global strategist at Los Angeles-based TCW Asset Management, which has about $118 billion (Dh433bn) in assets.

"They didn't do their job on time or adequately, and need to cut rates again as soon and as much as they can. They also need to start thinking of unconventional measures."

Trichet, 66, has resisted slashing the region's main refinancing rate as fast and as much as his US, Japanese and UK peers even as the $12 trillion euro economy headed for its worst recession since the Second World War.

While the ECB even raised the rate in July before reducing it 2.25 percentage points since October to two per cent, the Fed began lowering its target rate as early as September 2007, cutting it by five percentage points to a range of zero to 0.25 per cent. The Bank of Japan reduced its rate 0.40 percentage point to 0.10 per cent. The Bank of England lowered its rate by 4.75 percentage points to one per cent.

Yields on shorter-dated debt, which are more sensitive to the interest rate outlook, tumbled relative to longer-dated bonds, as investors bet the ECB will lower borrowing costs. The central bank next meets on March 5, and is likely to lower rates to 1.5 per cent, according to the median estimate of 29 economists surveyed by Bloomberg.

The so-called spread between two and 10-year German note yields, the benchmark government-debt securities for the euro region, widened to 198 basis points, or 1.98 percentage points, on February 6 from 82 basis points a year ago. The average in the past five years is 72 basis points. It was 180 basis points yesterday.

The trend, known as a steepening of the yield curve, may continue, according to John Stopford, a fund manager at Investec Asset Management in London. "We are very comfortable with curve steepening trades, and so far that works very well for us," said Stopford, who oversees about $12bn as global head of fixed income at Investec. "Economic data look dreadful and the ECB will have to play catch-up. They can cut by another 100 basis points."

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