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Weakening European economy may force rate cut

By David Mchugh

Associated Press

Published: Friday, Sept. 23 2011 6:05 a.m. MDT

FRANKFURT, Germany — The European Central Bank is facing mounting pressure to cut interest rates soon amid growing signs the eurozone economy could slide into recession.

Economists said Friday that the quickly worsening economic outlook could mean a rate cut could come as soon as October.

The bank raised rates by a quarter point in April and July to the current 1.5 percent, to ward off what then appeared to be growing inflationary pressures. But since then Europe's government debt crisis has worsened and in recent days leading indicators — data that suggest where the economy is going — have soured.

"Pressure is mounting on the ECB to quickly reverse its recent monetary policy tightening cycle rather than just halting it, with a near-term interest rate cut," said Howard Archer, chief European economist at IHS Global Insight.

"Falling prices charged in the services and manufacturing sectors combined in September add to the evidence that eurozone inflationary risks are rapidly dwindling and give the ECB scope to act."

The bank's 23-member governing council next meets on Oct. 6 in Berlin. Bank President Jean-Claude Trichet made it clear at a news conference Sept. 8 that the bank had halted its series of increases because the growth outlook had worsened and inflation risks had eased.

Keeping inflation under control is the bank's primary mandate and rate increases are its primary tool to do that. Rate cuts on the other hand can stimulate growth under the right conditions by encouraging business to borrow and expand, and freeing up some cash for households if their mortgages and credit card bills fall.

A run of downbeat data in recent days, including a closely watched index of industrial activity that registered outright contraction, and a dip in eurozone consumer confidence and industrial orders, has tilted the balance in favor of an imminent rate cut.

Royal Bank of Scotland economists said Friday they reckon there is a 60 percent chance the bank will slash rates by a half-percentage point at the Oct. 6 meeting. If the governing council can't agree on an October cut then RBS sees one in November or even between meetings; the council can confer and decide rates at any time.

Last month RBS expected a 40 percent chance of lower rates by year end. But the worsening economic outlook led to a shift in the prediction; the bank's economists now predict a eurozone recession, or drop in economic output.

Not all economists agree. Christoph Balz at Commerzbank reckons it would take a further worsening of the economic outlook, or a sudden escalation of the debt crisis, for the ECB to cut rates.

"The central bank will only consider a move on rates if it has to substantially trim back its recently lowered projections — provided the sovereign debt crisis does not escalate," he said.

A recession could complicate efforts to deal with Europe's debt crisis at a time when political leaders are trying to fend off a debt default by Greece that could shake the banking system and wider economy.

Greek and European officials are haggling over whether Athens has met conditions for another installment of its €110 billion bailout package, without which it will default next month.

Outside the 17 countries that use the euro, slowing growth in emerging markets could undermine Europe's export-oriented industry. German carmakers in particular recorded rich earnings in the first half of the year, largely because of booming sales in countries such as China, Brazil and Russia. But the World Trade Organization has cut its forecast for the increase in world trade to 5.8 percent from 6.5 percent.

Eurozone inflation ran at 2.5 percent annually in August, above the bank's goal of just under two percent. But the bank's projections show inflation falling below 2 percent by next year.

The EU's statistics office publishes its first estimate for inflation in September next Friday.

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