ECB to Cut Rates as Slump Calls for `Radical Action'

By Christian Vits

Nov. 6 (Bloomberg) -- The European Central Bank will cut interest rates for the second time in less than a month today as the region's economy suffers its worst slump in 15 years, economists said.

``It's time for radical action,'' said Ken Wattret, an economist at BNP Paribas SA in London. ``This is a very severe economic downturn, interest rates should come down a long way.''

ECB policy makers meeting in Frankfurt will lower the benchmark lending rate to 3.25 percent from 3.75 percent, according to 54 of 55 economists in a Bloomberg News survey. The ECB cut the rate by half a percentage point when it joined a globally coordinated move on Oct. 8 in response to the deepening financial crisis. President Jean-Claude Trichet last week signaled another reduction was likely.

Economists predict the ECB will reduce borrowing costs at the most aggressive pace in its 10-year history, taking its key rate to 2.5 percent by April as growth slows around the world. The economy of the 15 nations sharing the euro is probably already in a recession and will stagnate in 2009, the European Commission said this week.

The ECB announces its decision at 1:45 p.m. and Trichet holds a press conference 45 minutes later. Separately, the Bank of England will lower its key rate by half a point at noon in London, another survey of economists shows.

Trichet said last week a Nov. 6 rate cut was ``possible,'' with inflation pressures abating as the economy cools.

More Than Fifty?

Juergen Michels, a Citigroup Inc. economist in London, said the extent of the slump will prompt policy makers to slash rates by a full percentage point.

``Given the fall in inflation expectations and the bleak economic outlook, a rate cut of 100 basis points looks more likely,'' said Michels, the only dissenter in the Bloomberg survey. ``If the ECB lowers its benchmark by only half a point, it will flag another cut for December.''

Banks in Europe remain reluctant to lend to each other even after the ECB flooded them with cash and governments announced rescue packages to prevent banking failures. While the cost of borrowing euros for three months dropped to 4.66 percent yesterday from 5.39 percent a month ago, banks have been depositing record amounts of cash with the ECB overnight rather than lending to others.

The crisis that started with the U.S. housing slump and drove Lehman Brothers into bankruptcy caused the biggest global stock sell-off in 70 years.

Shrinking Economy

Economic growth in the euro area will slump to just 0.1 percent next year, the worst performance since 1993, the Brussels- based European Commission forecast on Nov. 3. It said the economy, which contracted in the three months through June, will probably continue to shrink in the third and fourth quarters.

Europe's manufacturing and service industries contracted at a record pace in October while executive and consumer confidence has slumped to a 15-year low.

``Interest rates have to be appropriate for the economic environment,'' ECB council member Axel Weber said Oct. 30. ``If the economy cools, then rates have to come down rapidly so one doesn't risk falling behind the curve.''

The Federal Reserve last week cut its benchmark to 1 percent from 1.5 percent and signaled it's ready to take rates to the lowest level on record. China and Japan have also reduced rates, and Australia this week slashed borrowing costs by three quarters of a percentage point.

Slowing Inflation

The ECB raised rates as recently as July, saying Europe's economic fundamentals were sound and inflation was a bigger threat than weaker growth. Since then, oil prices have more than halved from a peak of $147 a barrel.

Inflation slowed to 3.2 percent in October after reaching a 16-year high of 4 percent in July. Still, the ECB aims to keep the rate below 2 percent. Trichet has stressed the need for moderate pay increases, saying there's a risk of a wage-price spiral as workers seek compensation for the higher cost of living.

Lowering interest rates too much also risks re-fueling the excessive borrowing that led to today's problems, ECB Executive Board member Lorenzo Bini Smaghi said on Oct 31.

``The present crisis is partially due to interest rates that remained at low levels for too long,'' he said. ``At that time, rates were lowered too much in order to stimulate growth. We need to avoid repeating the same mistakes.''

To contact the reporter on this story: Christian Vits in Frankfurt at cvits@bloomberg.net