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ECB could cut rates and growth may near zero

  Euro zone economic growth could be close to zero next year and it is possible the European Central Bank will cut interest rates again next week, ECB policymakers said on Thursday.

 

Finland’s Erkki Liikanen, an ECB Governing Council member, also said central banks had to tread a fine line between curbing inflation and fending off the danger of deflation in times of great economic uncertainty. ECB Executive Board member Lorenzo Bini Smaghi and Governing Council member Miguel Angel Fernandez Ordonez both bolstered expectations the ECB will cut rates next week by echoing Monday’s comments by ECB President Jean-Claude Trichet that a rate cut at the next meeting is possible, although not certain. “We are in the quiet period, but I’ll say what Trichet said the other day,” Ordonez said at a business school event.

Speaking on Italian television, Bini Smaghi said: “Inflation is returning towards 2% and we are adapting monetary policy towards that.” Analysts expect the ECB to cut rates by 50 basis points on November 6, its second such reduction in less than a month, which would take benchmark credit costs to 3.25%. German Bundesbank President Axel Weber said central banks always aimed to be ahead of the curve, in periods of decelerating as well as accelerating economic activity, but declined to comment on the current rate outlook.

Liikanen, who also heads the Bank of Finland, said central banks had to take care that they did not overreact in their responses to financial shocks as history showed that financial crises, when not handled properly, had sometimes led to a deflationary cycle -- the first ECB policymaker to mention deflation even as a theoretical risk. “Monetary policy should also in times of great uncertainty work carefully between slowing inflation and stopping deflation danger,” he said in the text of a speech.

Economic data is increasingly showing the euro zone economy is in trouble. The European Commission said economic sentiment sank in October to its lowest since 1993 and suffered its sharpest monthly fall on record. The International Monetary Fund has forecast euro zone growth of just 0.2% next year and ECB policymakers are also growing more pessimistic about the outlook.

“I expect growth rates to be closer to zero than one percent,” Governing Council member and Dutch central bank Governor Nout Wellink told a parliamentary committee in the Hague. Weber told a banking function in Frankfurt he expected Germany’s economy, the euro zone’s largest, to gain strength next year.

 

BANANA SKIN

Wellink said the decision to allow the collapse of US investment bank Lehman Brothers, which sparked an intensification of the crisis, had marked a watershed. “It’s the banana peel on which you can slip and die,” he said. Ordonez, who heads the Spanish central bank, said previous periods of low rates were partly to blame for the crisis.

The ECB held rates at a historic low of 2% for 2-1/2 years until late 2005, while the Fed kept its benchmark rate at 1.0% for 12 months in 2003-2004. “The long period of reduced rates in the US, Europe and the rest of the world translated into an enormous level of leverage for the financial entities, companies and families which, while (it) stimulated economic growth, also permitted the accumulation of strong imbalances which have now so starkly materialized,” said Ordonez.

He was convinced, though, that October 8’s coordinated interest rate cuts by major central banks would eventually help to restore order. “While the decision has not immediately translated to market rates due to financial market crisis, it is a measure that, in the medium term, will help to recover confidence for consumers and businesses,” said Ordonez. (Reuters)