ECB Cuts Interest Rate By Half Point As Recession Grips Eurozone

The European Central Bank (ECB) today (Thursday) cut its benchmark interest rate by half a point to 3.25%. The reduction was widely expected, as economic growth has supplanted inflation as the central bank’s chief concern.

“Interest rates have to be appropriate for the economic environment,” ECB council member Axel Weber said Oct. 30. “If the economy cools, then rates have to come down rapidly so one doesn’t risk falling behind the curve.”

Gross domestic product (GDP) in the 15-nation Eurozone contracted by 0.2% in the second quarter, and the European Commission said Nov. 3 that the economy probably shrank by 0.1% in the three months ended September 30.  The executive branch of the European Union also lowered its 2008 forecast to 1.2%, saying the economy will probably shrink another 0.1% in the fourth quarter.

“The economic horizon has now significantly darkened as the European Union economy is hit by the financial crisis that deepened during the autumn and is taking a toll on business and consumers,” EU Economic Affairs Commissioner Joaquin Almunia said in a statement. “In 2009, the EU economy is expected to grind to a standstill.”

The EC predicted economic growth in the 27-nation EU will be a paltry 0.1% in 2009.  However, many analysts - including those with BNP Paribas SA (BNP), Citigroup Inc. (C) and Royal Bank of Scotland PLC (RBS) - believe even that figure is generous.

“A recession in 2009 seems now unavoidable,” Jacques Cailloux, chief Eurozone economist at Royal Bank of Scotland, told Bloomberg News. “Today’s new GDP forecast of 0.1% for 2009 by the European Commission still looks too optimistic to us.”

Given the likelihood of recession, the ECB may continue to cut rates well into the spring season of 2009.  Economists polled by Bloomberg say that the central bank could cut the current 3.25% rate to 2.5% by April.

The ECB raised rates as recently has July but has backtracked, as inflation has slowed.
Inflation cooled to 3.2% in October after soaring as high as 4% in July. The EC says that inflation will ease even further in 2009 to 2.2%.

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