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ECB makes record rate cut

The European Central Bank made its biggest ever cut to interest rates on Thursday, lowering benchmark credit costs by 75 basis points as it forecast a gloomy year ahead for the recession-bound euro zone economy.

But ECB President Jean-Claude Trichet refused to give any guidance on whether more would follow after the latest cut -- the third in less than two months -- took the main interest rate to a 2-1/2 year low of 2.50%. “I exclude nothing but I am not precommitting on anything,” he told a news conference. “We will look at what is necessary at any time.”

Thursday’s rate cut, though big by ECB standards, was tame compared with a 100 basis point reduction made by the Bank of England, 150 points by the Reserve Bank of New Zealand and a stunning 175 points by Sweden’s central bank earlier in the day. These had fanned market expectations that the ECB would break with tradition and take a step up in its response to the economic problems now rattling the 15 nation euro zone. ECB staff forecast the economy will contract in 2009 while inflation falls well below the central bank’s 2% price stability ceiling.

Still, most economists had expected a smaller, 50 basis point step this month, especially given several policymakers had warned against large rate cuts in recent weeks. One of those, Luxembourg’s Yves Mersch, said the ECB was not planning to keep up the more rapid pace and would likely take a pause for the time being. “With 2.5% we still have a little bit of margin. However, in the future we will not see such clear rate cuts. We are returning to normal territory, with changes to benchmark rates of 0.25 percentage points,” he told the Tageblatt newspaper.

In contrast to previous months, Trichet said Thursday’s decision was by consensus, rather than unanimous, and declined to say whether policymakers discussed any other options or to give any indication of further action on at the January 15 meeting. “For January I say nothing,” he said, when asked if investors were right to bet on another 50 basis point cut.

Economists said this reticence showed the ECB was trying to buy time and strike a balance between decisive action and not exhausting all its firepower. Most predicted another cut in January anyway, to 2%, which would match the previous record low maintained between 2003 and 2005.

A Reuters poll showed 44 of 51 economists see a January cut, although five thought the ECB would hold back until February. Median expectations are for 1.5% by mid-year. “Being far behind the curve, the ECB has been stuck in a new balancing act between cutting rates aggressively to get ahead of the curve without at the same time losing all ammunition,” said ING economist Carsten Brzeski.

The euro initially fell against the dollar after the decision and trimmed gains against sterling but later rebounded to around its highest levels of the day.

FORECASTS SLASHED

Euro zone government bond yields pulled back from multi-decade lows as the BoE and ECB rate decisions disappointed and Trichet gave little away on the chances of more easing. Quizzed repeatedly about the scope for future moves, Trichet stressed that the ECB had already chopped 175 basis points from euro zone borrowing costs in less than two months, and wanted to see those past decisions take effect.

Although money market rates have fallen sharply in the last two months, he noted the gap between bank-to-bank costs and anticipated official rates remains high. Also, with rates now rapidly approaching 2%, the ECB had to “beware of being trapped at nominal levels that would be much too low.” The central bank was prepared to consider other measures, such as directly buying assets, he said.

Euro zone politicians welcomed the bumper cut, with German Economy Minister Michael Glos saying it sent a positive and confidence-building signal to markets and firms. Still, the ECB joined other institutions in sharply revising down the outlook for growth and forecasting a contraction in the 15-naation region next year.

Eurosystem staff forecasts for 2009 growth were cut to a range of -1.0 to 0.0%, giving a mid-point projection that the euro zone economy would shrink 0.5% next year. This compares with a forecast of 2009 growth between 0.6 and 1.8% issued in September. For the first time, staff forecasts stretched to 2010 and predicted growth would recover to between 0.5 to 1.5%.

Trichet also added an extra note of caution. “The outlook remains surrounded by an exceptionally high degree of uncertainty. Risks to growth lie on the downside,” he said. ECB staff also predicted inflation was likely to average around 1.4% in 2009 -- below the threshold for the first time since 1999 -- with sharp falls likely around mid-year.

But Trichet said this would be only temporary, with increases in inflation rates possible in the second half of the year, and said he did not see deflation. “Risks to price stability are more balanced than in the past,” he said. In 2010, inflation is seen between 1.5-2.1%. (Reuters)