PREVIEW: European central banks set to cut rates as economy slumps

By Andrew McCathie Dec 2, 2008, 12:17 GMT

Berlin - The European Central Bank (ECB) and the Bank of England (BoE) are set to deliver further steep reductions in borrowing costs this week as the wave of rate cuts across the global economy gains momentum.

Amid signs that global economic contraction is picking up speed and that inflationary pressures are fading, the ECB meeting in Brussels and the BoE convening in London are expected to announce on Thursday they have slashed the cost of money by at least 50 basis points.

This would bring the ECB's refinancing rate down to 2.75 per cent, while a 50-basis-point reduction would lower British borrowing costs to 2.5 per cent and represent the BoE's third consecutive monthly rate cut.

However, some economists believe that both the ECB and the BoE will be forced to slash rates by more and to deliver 75 or even 100- points cut in a bid to haul Europe out of recession.

But the Frankfurt-based ECB has never cut rates by more than 50 basis points so a 75 or 100-basis-point reduction this week at what is one of its regular out-of-town meetings in Brussels would serve to underscore the gravity of the threat facing the European economy.

Indeed, since the BoE surprised markets last month with a dramatic 150-basis-point reduction, grim economic indicators have continued to roll in as a result fuelling speculation about the depth of the British recession with the manufacturing purchasing managers' index tumbling to an all-time low.

At the same time, while figures showed Britain's annual inflation rate recording its biggest monthly fall in 16 years in October to drop to 4.5 per cent, data has also showed production and industrial orders slumping, house prices plunging, consumer spending sinking and unemployment rising amid continuing tight credit markets.

'So with bank credit continuing to dry up and activity slowing in a dramatic fashion, we look for the BoE to cut rates by 100 basis points this Thursday with rates down to just 1 per cent in early 2009,' ING economist James Knightley said.

But even if the BoE's monetary policy committee and the ECB's rate-setting governing council decide against reducing the cost of borrowing by more than 50 basis points this week, economists are predicting that Europe's two leading central banks will press on with their rate-cutting cycle well into the new year.

Economic sentiment in the eurozone tumbled to a 15-year low in November, a key survey released last week showed, after the currency bloc tipped into recession in the third quarter.

This is already starting to filter through to the eurozone's jobs market, with unemployment posting its biggest monthly increase in October surging to 7.7 per cent, which was its highest level in nearly two years.

At the same time, annual eurozone inflation last month chalked up its biggest fall in almost 20 years, dropping to a lower-than- forecast 2.1 per cent in November from 3.2 per cent in October.

The fall in the November inflation rate took consumer prices back down close to the ECB's 2-per-cent target for annual inflation after it hit a 16-year high of 4 per cent in June as oil prices headed towards a record of nearly 150 dollars a barrel.

But since then oil prices have been in retreat, crashing to a 22- month low of under 50 dollars a barrel last month as a slowing world economy hits energy demand.

Falling inflation 'gives the ECB room to continue to cut rates quickly,' said Commerzbank economist Christoph Weil, who predicts that eurozone inflation could drop to as low as 1 per cent by early next year.

Adding to the pressure on the banks to go further than 50 basis points this week has been the series of rapid-fire cuts delivered by the US Federal Reserve as well as the moves to ease monetary policy around the world with Switzerland's normally conservative national bank last month chopping 100 basis points off rates.

Last week, China also announced a 108-point cut, which was the biggest reduction in borrowing costs in the country since the Asian financial crisis a decade ago.

In the meantime, Sweden's central bank said it was bringing forward its regular meeting by about two weeks to Wednesday, sparking speculation that the Riksbank was likely to slash rates again.

On Tuesday, an emergency meeting of the Bank of Japan agreed to a series of new measures to help free up corporate financing.

Earlier on Tuesday, Australia's Reserve Bank delivered its fourth rate cut in as many months slashing rates by 100 basis points to a six-and-a-half year low of 4.25 per cent with economists predicting more reductions are on the way.