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ECB rate cut eyed as euro crisis bites

Jun 03 2012 13:01 AFP

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Frankfurt - The European Central Bank may cut interest rates again soon as the eurozone debt crisis deepens, but it will continue to insist that it is up to governments to find a lasting solution, analysts say.

ECB watchers predict the central bank - which will hold its regular policy-setting meeting next week on Wednesday instead of Thursday owing to a public holiday - will not alter borrowing costs just yet this month.

But it could act in July as deepening fears about Greece and possible contagion to other countries push the 17 countries that share the euro back into recession, the analysts predicted.

"The further escalation of the eurozone crisis has intensified the pressure on the ECB to take further remedial action," said Capital Economics' chief European economist Jonathan Loynes.

"But while president (Mario) Draghi may hold open the prospect of further support of the region's banks after the meeting on June 6, he is likely to insist again that it is up to national policymakers to address their broader economic and fiscal problems," Loynes said.

The ECB has never hesitated to act from the very beginning of the crisis.

It quickly reversed last year's rate hikes to bring eurozone borrowing costs back down to an all-time low of 1.0% and embarked on a hotly contested programme of indirectly buying up the bonds of debt-mired countries.

Most recently, in two so-called long-term refinancing operations (LTROs) in December and February, it pumped more than €1.0 trillion into the banking system to avert a dangerous credit squeeze in the euro area.

Nevertheless, ECB officials have all along insisted that such measures cannot cure the root cause of the crisis - profligate spending by governments.

"Can the ECB fill the vacuum of lack of action by national governments on fiscal growth? The answer is no," Draghi said again during a hearing at the European parliament last week.

The ECB argues that its overriding priority, even in times of crisis, is to keep a lid on inflation in the single currency area.

The latest data indicate that price pressures are indeed under control - area-wide inflation slowed to 2.4% in May from 2.6% in April and in Germany, the bloc's biggest economy, inflation slowed to 1.9%, its lowest level in 17 months.

Further up the inflation pipeline, too, the money supply expanded by just 2.5% in April, a sharp slowdown compared with the previous month, despite the huge amounts of liquidity pumped into the system via the ECB's anti-crisis measures.

"With the inflation threat receding, the ECB has more scope to stimulate the economy," argued Berenberg Bank chief economist Holger Schmieding.

The ECB will also publish its latest quarterly staff projections on inflation and economic growth on Wednesday.

They are likely to be revised downwards, "leaving the door open for further policy accommodation," said Newedge Strategy analyst Annalisa Piazza.

She saw a "60% chance" that the ECB would trim its rates by a quarter of a percentage point to 0.75% as early as this month.

Nevertheless, "the timing of a rate cut is highly uncertain," the analyst cautioned.

While the "weaker fundamentals and increasing stress in financial markets fully justify a quarter-point cut this week, the ECB might decide a later cut is the best tactical option" as borrowing costs are already at record lows and the full effects of the anti-crisis measures have yet to unfold, she argued.

Berenberg Bank's Schmieding, too, saw a "good case" for a quarter-point rate cut.

But the bank would probably wait until July by which time the outcome of the Greek parliamentary elections on June 17 will be known, the economist argued.

Greece is heading to the polls for a second time in six weeks after an inconclusive vote on May 6. And with the radical leftist Syriza party, chief opponent of a massive EU-IMF bailout accord, tipped to win this time, the election could lead to Greece quitting the single currency.

Commerzbank economist Michael Schubert also predicted the ECB would hold rates steady again this week, "not least because it wants to maintain the pressure on politicians."

Nevertheless, ECB chief Draghi would "leave the door wide open for further action," Schubert said.

ecb  |  interest rates  |  europe debt crisis
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