Bonello Says ECB Plans to Take `Prudent Approach' on Rates

By Blanche Gatt and Gabi Thesing

Oct. 7 (Bloomberg) -- European Central Bank council member Michael Bonello said policy makers plan a ``prudent approach'' when weighing the need for lower interest rates as the credit crunch clouds the outlook for the economy.

``We will be assessing the information as it comes in and take a decision at the next meeting after due deliberation,'' Bonello, who heads Malta's central bank, said in an interview in Valletta yesterday. ``Particularly in these uncertain times, that is the most prudent approach to take.''

Investors raised bets the ECB will cut rates in November after President Jean-Claude Trichet on Oct. 2 said inflation pressures are easing as growth slows. The financial crisis is worsening in Europe, with governments forced to bail out banks and guarantee consumers' deposits after credit costs soared to records. Europe's Dow Jones Stoxx 600 Index yesterday plunged the most since 1987, dropping 7.6 percent.

``Major efforts are being made to mitigate the impact of the financial turmoil on the real economy, but you have various elements at play in different countries and what the overall impact is going to be at the end of the day is unpredictable,'' said Bonello, 63. ``There are several indications that the tempo of activity is slowing down, but we have to wait for the GDP number for the third quarter to know exactly the extent of this weakening.''

The economy of the 15 nations sharing the euro contracted 0.2 percent in the second quarter and third-quarter gross domestic product figures are due on Nov. 14. The ECB will publish new growth and inflation forecasts in December.

Rate-Cut Bets

The Frankfurt-based central bank last week left its benchmark interest rate at 4.25 percent, a seven-year high. Investors have fully priced in a reduction to 4 percent by December, Eonia forward contracts show.

The world's biggest financial institutions have recorded almost $600 billion in writedowns and losses tied to the U.S. mortgage market since the start of 2007, driving Lehman Brothers Holdings Inc. into bankruptcy on Sept. 15 and forcing governments to rescue banks in the U.S., U.K. and Europe.

Bonello, who declined to comment on specific bailouts, said the measures are ``all designed to restore confidence.''

The ECB has held off cutting rates because of its concern that the jump in inflation will become entrenched through a wage- price spiral as workers seek compensation for the higher cost of living.

While inflation in Europe slowed to 3.6 percent in September after crude oil prices retreated from a July record of $147.27 a barrel, it is still above the ECB's 2 percent limit. Trichet said Oct. 2 that inflation risks have ``not disappeared.''

``The Governing Council has repeatedly warned that second- round effects, which come from the impact of past energy and food-price increases on price and wage-setting behavior, risk setting off a wage-price spiral,'' Bonello said. ``That would make domestic goods and services less competitive on foreign markets, it would threaten output and employment, so that is something which one wants to avoid as much as possible.''

To contact the reporters on this story: Blanche Gatt in Malta at bgatt@bloomberg.net; Gabi Thesing in Frankfurt at gthesing@bloomberg.net.