The European Central Bank is set to cut its main lending rate sharply this week as inflation is falling fast and the eurozone economy badly needs a monetary shot in the arm, analyst says.
"We look for the ECB to reduce rates by 50 basis points at its November meeting, and to follow up with a further 50 bp cut no later than January," Bank of America senior economist Holger Schmieding said.
That would take the rate from 3.75 percent at present to 3.25 percent. "The receipe for aggressive rate cuts is complete in our view," UBS economist Sunil Kapadia added.
The 15-nation eurozone economy is slumping heavily, with a key purchasing manager's index falling to a record low in October and business confidence hitting its weakest level since November 1993. The economy contracted by 0.2 percent in the second quarter and would meet the technical definition of a recession if it shrank again in the third.
Stock markets have been rocked by heavy losses meanwhile as investors seek to convert whatever they can into cash. Unemployment appears set to begin rising again next year. But the international financial crisis and global slowdown have also triggered a plunge in oil prices, which stood at around 64 dollars a barrel on Friday, well off their high of 147 dollars in July. That trend has eased pressure on inflation, which had hit a record 4.0 percent in July.
Inflation is now at 3.2 percent according to an EU estimate, and should fall further towards the ECB's medium-term target of just below 2.0 percent.
Central banks in Tokyo and Washington cut their main lending rates last week to 0.3 percent and a record low of 1.0 percent, respectively. And the Bank of England is tipped to slash its rate on Thursday from 4.50 percent by at least half a percentage point, with Citbank saying it could for a full point, though the BoE has never exceeded a half-point change in the past. On October 8, the ECB cut its rate by a half point to 3.75 percent in an exceptional joint action that included the US Federal Reserve, BoE, and central banks in Canada, China, Sweden and Switzerland. The euro now trades for around 1.27 dollars, well off its all-time high above 1.60 dollars in mid July, though the drop has not brought much relief to eurozone exporters owing to weaker global activity.
Bank lending however, has tightened despite unprecedented central bank moves that have seen massive amounts of the world's major currencies pumped into money markets.
ECB president Jean-Claude Trichet was expected Thursday to outline a forthcoming bank lending survey "which is likely to show that credit conditions are set to tighten much further," noted Capital Economics economist Jennifer McKeown. As a result, "we doubt that the bank will surprise markets with anything other than a 50 bp reduction," she added. UniCredit senior economist Aurelio Maccario believed that steep stock losses and falling inflation would lead the ECB to cut rates sharply "to try and cushion the impact of what clearly looks like the most adverse phase the eurozone has faced in its young history." The question now is how far the ECB could go in what is shaping up as a rapid cycle of rate reductions. McKeown staked out the low lands with a forecast that rates would "fall all the way to 1.5 percent next year," while most others were expecting the bank to go to 2.0 percent, its all-time low that stretched from June 2003 to December 2005.
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