Eurozone set for one last rate cut, analysts say

Posted 05 20 2009 5:27AM

FRANKFURT (AFP) – The eurozone is set for a seventh and final interest rate cut to a record-low 1.0 percent on Thursday, analysts say, and the unveiling of unconventional measures to ease the financial crisis.

European Central Bank governors meeting on Wednesday are "almost certain to cut interest rates by 25 basis points to 1.0 percent... where they should remain for some time," Capital Economics economist Jennifer McKeown said.

A poll of 43 banks by Dow Jones Newswires found all expected the ECB to trim 0.25 percentage points from its main rate, which would add up to a combined cut of 3.25 points since early October.

But "the key interest will be in how much more the bank will do," McKeown said. She looked for the ECB to "outline a framework for quantitative easing involving outright asset purchases even if it is not ready to take the plunge quite yet."

Quantitative easing (QE) is the creation of money by central banks to boost economic activity by buying government, bank or corporate bonds, or other kinds of private debt.

With the ECB nearing a lower limit in terms of interest rates -- several directors say 1.0 percent is as low as they will go -- the bank needs new ways to wrench the eurozone from a deep economic slump.

The European Commission warned Monday that the 16-nation economy would contract by 4.0 percent this year as an historic recession drives unemployment to levels not seen since World War II.

"The European economy is in the midst of its deepest and most widespread recession in the post-war era," EU Economic and Monetary Affairs Commissioner Joaquin Almunia said.

Unemployment is back in the spotlight amid fears that 8.5 million Europeans could lose their jobs in 2009 and 2010, driving the eurozone jobless rate to 11.5 percent next year.

The head of the Eurogroup of eurozone finance ministers Jean-Claude Juncker warned of a social crisis, saying: "We really must not underestimate the multitude of problems that can come hand in hand with a rise in the unemployment rate."

ECB governors have been reluctant to unveil bolder measures such as those already used by the US Federal Reserve and Bank of England.

The Fed's main interest rate, like that of the Bank of Japan, is effectively zero, while the BoE is expected to hold its rate at 0.50 percent when it meets this week.

And both the Fed and BoE have launched versions of QE by buying billions of dollars' worth of Treasury bills or government bonds from commercial banks to kick-start lending.

The ECB does not want to buy government debt, even from banks at the core of the eurozone financing system, and is more likely to extend the maximum length of its unlimited cash loans to one year from six months at present.

ECB president Jean-Claude Trichet could also tell markets the interest rate would stay at 1.0 percent for some time, a break from his vow never to "pre-commit" on monetary policy.

As for buying assets, an ECB statement "will probably also include a general operational framework for asset purchases, focusing on private sector paper but not government bonds, as a tool to ease credit conditions," Citi economist Michael Saunders said.

He said critics would call such a move weak however, because the share of such market-based funding in the eurozone is relatively small.

His Goldman Sachs counterpart Erik Nielsen added that such a move would also be "highly concentrated both in terms of sectors and in terms of country of issuance."

The latter issue is a thorny one for the ECB, which unlike other central banks must work for the good of 16 economies with often differing needs.

UniCredit chief eurozone economist Aurelio Maccario warned the ECB against excluding further rate cuts "and appearing shy and divided on further unconventional measures."

That could send a message that "the central bank is underestimating the exent of the crisis and/or that the ECB has run out of ammunition," he said.