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29 February 2024

ECB under pressure to cut lending rates

The Frankfurt-based bank has lowered the cost of borrowing much more slowly than its major counterparts. (AP)


The European Central Bank is under pressure to lower its main lending rate this week owing to stark evidence of a worsening recession and sinking inflation, analysts say.

"We expect the ECB to cut rates by 50 basis points (0.50 per cent) to two per cent, after the Bank of England cut rates by 50bp to 1.50 per cent last week," UBS Economist Stephane Deo said last week.

Other analysts note the cautious ECB, which has already reduced its rate by 1.75 per centage points in three moves since October, might opt for a cut of 0.25 points to leave itself room for manoeuvre.

The Frankfurt-based bank has lowered the cost of borrowing much more slowly than its major counterparts, especially the US Federal Reserve and Bank of Japan, which have now effectively set their benchmark rates at zero.

The Bank of England's cut last week brought British rates to their lowest level since the bank was created in 1694, a sign of how seriously the economic crisis is being taken in London.

Two top ECB officials have indicated this month that a rate cut could be on the way by highlighting the slumping economy and inflation that is falling so fast that some warn the eurozone could be hit by deflation this year.

ECB President Jean-Claude Trichet said: "It is clear that we have had a significant deterioration in the real economy.

"What strikes me is that the most recent projections are also the most pessimistic," he told the US magazine Institutional Investor.

Trichet had suggested last month that the bank might pause in its rate cutting cycle to assess the initial effects of earlier reductions.

ECB Vice-President Luca Papademous said in another interview: "If in our assessment, the risks to price stability change further in the coming months, monetary policy could be eased further."

Eurozone inflation is now estimated at 1.6 per cent, well below the ECB's target of "close to but below two per cent."

Price stability has often meant keeping inflation from soaring higher, but it now means making sure inflation does not fall so low that economic activity suffers.

Deflation causes consumers and businesses to conclude that prices will fall even more and delay purchases in the meantime.

Another good reason for lowering the cost of borrowing is to curb the eurozone's first economic recession, which began in the third quarter of 2008. European consumer and business confidence has plunged to its lowest level since the European Commission began its survey 23 years ago, while eurozone unemployment reached 7.8 per cent in November, its highest level in nearly two years.

In November, manufacturing activity fell to the lowest level in one survey's 11-year history, and industrial orders signal more gloomy news in store.

"It seems pretty clear that recession in the region has gathered pace rather than starting to abate," said Capital Economics economist Jennifer McKeown.

Given such an environment, a 0.50-point cut by the ECB "is what the economy needs and what the inflation outlook allows for," added UniCredit Markets Chief Eurozone Economist Aurelio Maccario.

"We are inclined to think that the ECB will proceed by small steps," he said.

Most observers are wondering when the central bank will take its rate below the current all-time low of two per cent, and how far it will go.

"What really matters at this stage is the ECB's willingness to move below the two per cent threshold in the next months," Maccario said.

McKeown added: "As it becomes clear that the recession will be worse than the ECB currently expects, we think that interest rates will fall more or less to zero later this year."

Others say the floor is more likely to be one per cent, but Deo at UBS said the US Federal Reserve's zero interest rate policy will force the ECB to cut rates sharply because otherwise the euro will gain against the dollar, hurting eurozone exporters.

"The Fed is exporting its monetary policy," Deo concluded.