ECB May Deliver Most Aggressive Interest-Rate Cut Yet

By Matthew Brockett

Dec. 4 (Bloomberg) -- The European Central Bank may be forced to deliver the most aggressive interest-rate cut in its 10-year history as the economic slump deepens.

Investors are now betting that ECB policy makers, meeting in Brussels today, will lower the benchmark lending rate by 100 basis points to 2.25 percent, the biggest single reduction ever, Eonia forward contracts show. Economists are divided, with 35 of 56 surveyed by Bloomberg News predicting a 50-point reduction and 21 forecasting a move of 75 points or more.

The ECB has so far refused to follow its counterparts from the U.K. to New Zealand in cutting rates by unprecedented amounts to limit the fallout from the global financial crisis. The central bank has instead restricted itself to two 50-point cuts since October and President Jean-Claude Trichet has stressed its role as an “anchor of stability.”

“The ECB seems to be engaged in a rarefied philosophical debate while the economy is totally collapsing around it,” said Julian Callow, an economist at Barclays Capital in London. “They do need to do a lot more and they need to do it quickly.”

The ECB, whose benchmark is the highest among the Group of Seven nations, announces its decision at 1:45 p.m. and Trichet holds a press conference in Brussels 45 minutes later. The bank’s Governing Council meets twice a year away from its Frankfurt headquarters.

Worldwide Cuts

The Bank of England will cut its key rate by 100 basis points to 2 percent today, a survey of economists shows, after last month lopping 150 points off its benchmark. That decision is due at noon in London.

New Zealand reduced rates by a record 150 points overnight, Indonesia unexpectedly cut for the first time in a year, and Sweden today lowered its key rate by 175 points to 2 percent. The U.S. Federal Reserve has cut its benchmark by 325 points this year, taking it to 1 percent.

With the 15-nation euro region spiraling deeper into recession, some economists say the time has come for the ECB to respond more forcefully to the crisis.

“Evidence that the economy will contract sharply in the fourth quarter, together with the prospect of a rapid decline in inflation, make a strong case for more aggressive action,” said Nick Kounis, chief European economist at Fortis Bank N.V. in Amsterdam. “The Governing Council will also have the benefit of a full update of its growth and inflation forecasts that will almost certainly show sharp downward revisions.”

Contracting Economy

Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing, the inflation rate fell the most in almost 20 years, to 2.1 percent from 3.2 percent.

The International Monetary Fund predicts the euro-region economy will contract 0.5 percent in 2009. Trichet will unveil the ECB’s revised growth and inflation projections at today’s press conference.

Some ECB policy makers have nevertheless advocated a steady- hand approach to tackling the recession and said they want the bank to keep its power dry, suggesting they would prefer to continue reducing rates in 50-point steps.

Executive Board member Lorenzo Bini Smaghi said on Nov. 25 that “sharp” rate reductions “may contribute to, rather than obviate, a worsening of market sentiment.” The same day, council member Ewald Nowotny told Bloomberg in an interview that he favors retaining some “firepower.”

‘Spaghetti Western’

“While the euro system’s banking sector is not in good shape, the situation is not as acute as the ones in the U.S. and the U.K.,” said Philip Lane, professor of international macroeconomics at Trinity College, Dublin. “Don’t forget, the euro has weakened considerably against the dollar, and that’s a substitute for a rate cut.”

The euro has dropped 20 percent against the dollar to $1.26 today from a July peak of $1.60, making European exports more competitive abroad.

Still, with the global economic downturn sapping demand for exports and causing an “unprecedented collapse in sentiment,” a bolder move from the ECB is “sorely needed,” said Holger Schmieding, chief European economist at Bank of America in London.

“At 3.25 percent now, the ECB is nowhere close to running out of rate-cut ammunition,” he said. “And letting the cavalry go under by refusing to shoot when the bad guys are closing in would not be a happy ending to a Spaghetti Western either.”

To contact the reporter on this story: Matthew Brockett in Frankfurt at mbrockett1@bloomberg.net