Trichet Says ECB Discussed Rate Cut as Growth Slowed

By Gabi Thesing

Oct. 2 (Bloomberg) -- European Central Bank President Jean- Claude Trichet indicated he's poised to cut interest rates as the credit crunch hurts the economy and damps inflation.

Investors are betting the ECB will lower borrowing costs as soon as next month after Trichet told a press conference in Frankfurt that policy makers discussed a rate reduction today. While leaving the benchmark at a seven-year high of 4.25 percent, Trichet said financial-market turmoil is damping economic growth and inflation risks ``have diminished.''

The financial crisis reached new heights in Europe this week as governments stepped in to help rescue five banks and credit costs soared to records. With the euro-region economy on the brink of a recession and retreating oil prices pushing down inflation, the ECB has more room to lower rates.

``Evidently the governing council has woken up and smelt the coffee,'' Julian Callow, chief European economist at Barclays Capital in London, said in a note to investors. Trichet is ``clearly signaling a policy cut is in the works. The question is November or December.''

The euro plunged more than a cent to $1.3748, the lowest since Sept. 7 last year, after Trichet spoke. Bonds rose, pushing the yield on the two-year note down 12 basis points.

BOE, Fed

Marks & Spencer Group Plc, the U.K.'s largest clothing retailer, today urged the Bank of England to cut interest rates, saying it would ``give confidence to consumers.'' The BOE, whose key rate is currently at 5 percent, next decides on borrowing costs on Oct. 9.

Investors are certain that the U.S. Federal Reserve will lower its key rate by at least a quarter point on Oct. 29, according to Fed funds futures.

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 and forcing governments to rescue banks in the U.S., U.K and Europe.

At the same time, the ECB remains concerned 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 31 percent from a July record of $147.27 a barrel, it is still above the ECB's 2 percent limit.

``Upside risks to price stability have diminished somewhat but they haven't disappeared,'' Trichet said today.

No Hurry

``It certainly didn't strike us that Trichet was in a hurry to bring rates down,'' said Philip Shaw, chief economist at Investec Securities in London. ``He said price risks are still there, but he gave himself sufficient flexibility to move if there was a worsening in the economic outlook.''

Companies may be reluctant to raise prices as the economy of the 15 euro nations shows few signs of recovering from a contraction in the second quarter. The manufacturing, services and retail sectors all shrank for a fourth month in September and confidence in the economic outlook is the lowest since the slump following the Sept. 11 terrorist attacks in 2001, according to the European Commission.

With credit markets freezing as banks refuse to lend to each other, the ECB has injected billions of euros and dollars into the banking system. That hasn't stopped money-market rates from surging.

France, Belgium, Luxembourg and the U.K. rescued lenders this week and Italian Prime Minister Silvio Berlusconi pledged to prevent losses for depositors.

Trichet will join leaders from France, Britain, Italy and Germany in Paris on Oct. 4 to discuss the crisis. He said today that a government-sponsored bailout of banks similar to the $700 billion plan proposed by U.S. Treasury Secretary Henry Paulson would not ``fit the political structure of Europe.''

To contact the reporter on this story: Gabi Thesing in Frankfurt at gthesing@bloomberg.netSimone Meier in Frankfurt at smeier@bloomberg.net