Nowotny Says ECB Should Keep ‘Firepower,’ Be Cautious

By Simone Meier and Andreas Scholz

Nov. 25 (Bloomberg) -- European Central Bank council member Ewald Nowotny said he favors the bank retaining some “firepower” as it tackles the recession, suggesting he sees no need for more aggressive interest-rate cuts yet.

“Nobody really knows how this very difficult economic situation that we have now will develop,” Nowotny, who heads Austria’s central bank, said in an interview with Bloomberg Television in Vienna yesterday. “It makes sense to be rather cautious and keep some of the firepower, and that means of course that you cannot use it up all in one go.”

ECB Executive Board member Lorenzo Bini Smaghi joined Nowotny today in urging a measured response to Europe’s deepening economic slump, saying “sharp” rate cuts may exacerbate negative sentiment. Both spoke after reports showed German business confidence plunged to a 16-year low and Europe’s manufacturing and service industries contracted at the fastest pace on record.

“If they cut rates very aggressively, it could give a sense of alarm,” said Gilles Moec, an economist at Bank of America Corp. in London. “They’re trying to rein in market expectations.”

Investors are betting the ECB will lower its benchmark rate by at least 75 basis points at its next meeting on Dec. 4, stepping up its policy response to the worsening economic outlook after two 50-point cuts to 3.25 percent in the past two months.

Worse Than Expected

“We will see whether we go more or less the way we did in the last months or whether there will be some change in the mood, but this all depends on the discussion we’re going to have in December,” Nowotny said. Still, “the way the ECB has acted so far, I believe that we’ll continue in this manner,” he said.

The economy slipped into its first recession in 15 years in the third quarter after the global financial crisis pushed up lending costs and eroded demand for European exports.

The Organization for Economic Cooperation and Development said today it expects the euro-region economy to shrink 0.6 percent next year after growing 1 percent in 2008. The Paris-based OECD called on the ECB to cut its key rate to 2 percent.

“We see a very rapid and stronger negative economic development than expected,” Nowotny said. “It’s safe to expect that given the very difficult economic situation, one has to respond to this with some rate cuts.”

‘More Cautious’

Eonia forward contracts show investors have fully priced in a drop in the ECB’s key rate to 2 percent in January. Nowotny declined to rule out a move to 2 percent, saying that the bank “will see how things develop” in coming months.

The U.S. Federal Reserve has reduced its key rate by 3.25 percentage points to 1 percent so far this year and the Bank of England lowered its benchmark by 1.5 percentage points last month alone, taking it to 3 percent. The Swiss central bank on Nov. 20 cut its key rate by 1 percentage point to 1 percent in an unscheduled move.

“The ECB is certainly a little bit more cautious and doesn’t want to use all its ammunition at once,” Nowotny said. “The ECB’s policy so far has proven right.”

Still, the bank has room to focus on reviving the economy as retreating oil and food prices push down inflation.

Nowotny, 64, a former economics professor who took the helm of Austria’s central bank on Sept. 1, said he expects inflation to average just below 2 percent next year. That would see the ECB achieve its definition of price stability for the first time in 10 years.

‘Deep, Deep Slowdown’

“As we’ve had such a deep, deep slowdown of the economy, I expect that inflationary expectations will be rather stable for quite some time,” Nowotny said. “So, that doesn’t mean that interest rates will automatically go up.”

While central banks shouldn’t keep borrowing costs low “for too long” and need to “remove the punch glass when the party is at its best,” Nowotny noted that “the party isn’t yet doing especially well.”

The credit crisis worsened after the collapse of Lehman Brothers Holdings Inc. in September, sparking the biggest global stock sell-off in 70 years. The world’s biggest financial companies have posted almost $1 trillion in writedowns since the start of last year, when the collapse of the U.S. subprime mortgage market triggered a credit shortage.

The ECB, along with the world’s largest central banks, has injected billions into money markets to help restore lending among commercial banks, while governments across Europe have launched stimulus packages to bolster their economies.

Nowotny said the economy may start to recover in the second half of 2009.

“I would think that there is a chance that this slowdown could end by the middle of next year, because a number of countermeasures have been taken with regard to the banking sector, with regard to the real economy,” he said. “All this needs some time to work through.”

To contact the reporters on this story: Simone Meier in Frankfurt at smeier@bloomberg.net; Andreas Scholz in Frankfurt at agscholz@bloomberg.net.