ECB Delivers Biggest Rate Cut Ever as Economy Slumps

Dec. 4 (Bloomberg) — The European Central Bank cut interest rates the most in its 10-year history after the region’s economy suffered the first recession since the introduction of the euro.

ECB policy makers meeting in Brussels lowered the benchmark lending rate to 2.5 percent from 3.25 percent. Only 17 of 56 economists in a Bloomberg News survey correctly forecast the move, with 35 predicting a cut of 50 basis points and 4 calling for a full percentage-point reduction.

The ECB’s decision came after the Bank of England today cut its key rate by one percentage point to 2 percent, the lowest level since 1951, and Sweden’s Riksbank pared rates the most in 16 years. The Federal Reserve’s benchmark rate now matches a five- decade low as central banks rush to respond to the global recession.

“This is better than 50 basis points, but they are still late coming to the party,” said Laurent Bilke, an economist at Nomura International in London who used to work as a forecaster at the ECB. “The economy is in deep recession now, so rates should come down as quickly as possible.”

“Global and euro-area demand are likely to be dampened for a protracted period of time,” ECB President Jean-Claude Trichet said at a press conference in Brussels. The bank’s Governing Council meets twice a year away from its Frankfurt headquarters.

Worldwide Cuts

The ECB’s move is the latest in a round of rate reductions across the globe today.

The Bank of England had already lopped 150 points off its benchmark last month. Sweden’s Riksbank today sliced 175 points off its main rate, taking it to 2 percent, New Zealand cut by 150 points and Indonesia unexpectedly lowered borrowing costs for the first time in a year. The U.S. Federal Reserve has reduced its key rate by 325 points this year, taking it to 1 percent.

“The ECB tends to be more conservative, with more of a steady-hand policy,” said Nick Kounis, chief European economist at Fortis Bank in Amsterdam. “With the economy contracting sharply, it’s time to step up the pace of rate cuts.”

Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing, the inflation rate fell the most in almost 20 years last month, to 2.1 percent from 3.2 percent in October.

‘Firepower’

The International Monetary Fund predicts the euro-region economy will contract 0.5 percent in 2009.

“We’ve seen a significant deterioration in the business environment in the past few weeks and that will require a serious monetary stimulus,” said Marc Stocker, director of economics at the BusinessEurope lobby group in Brussels. Still, “the economic slowdown is not over, so it’s important for the ECB to keep its powder dry.”

Some ECB policy makers have advocated a measured approach to tackling the recession. Executive Board member Lorenzo Bini Smaghi said on Nov. 25 that “sharp” rate reductions “may contribute to, rather than obviate, a worsening of market sentiment.” The same day, council member Ewald Nowotny told Bloomberg in an interview that he favors retaining some “firepower.”

“While the euro system’s banking sector is not in good shape, the situation is not as acute as the ones in the U.S. and the U.K.,” said Philip Lane, professor of international macroeconomics at Trinity College, Dublin. “Don’t forget, the euro has weakened considerably against the dollar, and that’s a substitute for a rate cut.”

Weaker Euro

The euro has dropped 20 percent against the dollar to $1.26 today from a July peak of $1.60, making European exports more competitive abroad. It was little changed after today’s rate decision and traded at $1.2623 at 2:15 p.m. in Frankfurt.

Companies are nevertheless seeing export orders dwindle as the global economic slowdown curbs demand. MAN AG Chief Executive Officer Hakan Samuelsson said this week that Europe’s third largest truck maker is bracing for “a very difficult 2009” and will slash output at its main unit by 30 percent.

BASF SE, the world’s largest chemical company, last month lowered its 2008 profit forecast for the second time and said it plans to idle 80 factories after customers reduced orders.

“The economy has fallen off a cliff and it seems like the ECB’s not looking out the window,” said Julian Callow, chief European economist at Barclays Capital in London. “A 100 basis- point cut would have been much better.”

To contact the reporter on this story: Gabi Thesing in Frankfurt at gthesing@bloomberg.net

Last Updated: December 4, 2008 09:36 EST
By Gabi Thesing

Source: Bloomberg

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