ECB Cuts Key Rate

The European Central Bank cut its benchmark interest rate by half a percentage point to 2 percent, matching a record low, as the deepening recession pressed policy makers into action., Bloomberg 1/15/2009 5:15:50 AM

The reduction, the fourth in as many months, was in line with the median forecast of 60 economists in a Bloomberg News survey. The rate was last at this level between 2003 and 2005. The Frankfurt-based central bank, which took charge of monetary policy in 1999, will reduce the benchmark to 1.5 percent in March, another survey of economists shows.

President Jean-Claude Trichet said last month there’s a limit to how far the ECB can cut rates and refused to give any signal for January, suggesting he favored a pause. At the same time, the economy of the 16 euro nations is deteriorating more rapidly than the ECB anticipated as the global financial crisis hurts exports, damps spending and threatens credit ratings in the region.

The ECB still has the highest rates among the Group of Seven industrialized nations. The U.S. Federal Reserve, the Bank of England and the Swiss central bank have cut borrowing costs more aggressively as the world’s largest economies slide simultaneously into recession for the first time since World War II.

The Bank of England on Jan. 8 reduced its main lending rate to 1.5 percent, the lowest since it was founded in 1694. The Fed last month lowered its key rate to a target range of zero to 0.25 percent. Japanese and Swiss rates are also close to zero. Canada’s rate is at 1.5 percent.

The ECB has reduced its benchmark by 225 basis points since early October. Last month it lowered the rate by 75 points, its biggest step ever.

The faltering economy is hurting budgets in some euro-region countries. Standard & Poor’s yesterday lowered Greece’s sovereign credit rating one notch to A-, saying the financial crisis has exacerbated an underlying loss of competitiveness.” The ratings of Ireland, Portugal and Spain are also under threat.

European confidence has plunged to the lowest on record, industrial production posted it biggest annual drop in 18 years in November and unemployment rose to 7.8 percent in November, a two- year high.

The German economy, Europe’s largest, may have contracted as much as 2 percent in the fourth quarter, the country’s statistics office said yesterday. That would be the biggest slump in more than two decades.

Some council members had signaled a willingness to lower borrowing costs further. ECB Vice President Lucas Papademos and Portugal’s Vitor Constancio both said this month that lower rates may be warranted if the inflation rate drops too far below 2 percent, the bank’s definition of price stability.

The rate declined to 1.6 percent in December.

The ECB last month forecast inflation would average 1.4 percent this year and 1.8 percent in 2010. It predicted the economy would contract 0.5 percent in 2009 before rebounding to expand 1 percent in 2010.

The shadow ECB council, a group of economists that monitors the central bank, said on Jan. 13 that a half-point reduction in rates may not be enough and called for a full percentage point cut. A worsening recession increases the risk of excessive disinflation,” and this should be as much a concern to the ECB as inflation above its target, the economists said.

Investors expect the ECB to lower the benchmark rate to as low as 1.25 percent by June, Eonia forward contracts showed before today’s decision.

ECB Cuts Key Rate