ECB’s Trichet Says Euro-Region Economy Will Contract

By Gabi Thesing

Dec. 4 (Bloomberg) -- European Central Bank President Jean- Claude Trichet said the euro region’s economy will shrink next year for the first time since 1993 after the bank delivered the biggest interest rate cut in its 10-year history.

“Global and euro-area demand are likely to be dampened for a protracted period of time,” Trichet said at a press conference in Brussels today. The ECB lowered its benchmark by three quarters of a percentage point to 2.5 percent. Trichet declined to give clues on further moves, saying only that the ECB shouldn’t get “trapped” by cutting rates too low.

The ECB’s decision came after the Bank of England today cut its key rate by one percentage point to 2 percent and Sweden’s central bank lowered borrowing costs by the most since 1992. The Federal Reserve’s benchmark rate now matches a five-decade low as central banks rush to respond to the global recession.

“The level of uncertainty remains exceptionally high,” Trichet said. The euro rose after his comments and traded at $1.2681 at 3:50 p.m. in Brussels.

As well as cutting rates, the ECB has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said today it may be possible for the bank to purchase financial assets outright to reflate the economy, although he declined to say if it would.

Trapped

Trichet said the euro region’s gross domestic product will shrink around 0.5 percent next year as the financial turmoil takes its toll, the first time the ECB has ever predicted a contraction. In September, the bank forecast a 1.2 percent expansion next year.

“The ECB is moving towards an acceptance of reality but the growth projections are still not low enough,” said Ken Wattret, euro area chief economist at BNP Paribas in London.

Trichet refused to be drawn on further moves, saying only that policy makers must avoid getting “trapped at nominal levels that would be too low.” The ECB’s benchmark compares with the Fed’s rate of 1 percent.

On inflation, Trichet said it will slow to about 1.4 percent in 2009 from 3.3 percent this year.

“Overall, since our last meeting, evidence that inflation pressures are diminishing has increased,” Trichet said. “Inflation rates are expected to be in line with price stability over the relevant policy horizon.”

Anchor

Until today, the ECB had restricted itself to two 50-point cuts since October, with Trichet stressing its role as an “anchor of stability.”

Some ECB policy makers have advocated a steady-hand approach to tackling the recession. 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,” prompting speculation the bank would limit itself to a half-point cut today.

Trichet said today’s decision was made by consensus and declined to divulge if there were calls for smaller or bigger cuts.

“This suggests to us that the decision might have been more difficult to reach than at the last meeting with possibly some members favoring a smaller cut,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Plc in London.

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 last month, to 2.1 percent from 3.2 percent in October.

Contraction

The International Monetary Fund predicts the euro-region economy will contract 0.5 percent in 2009.

Trichet declined to follow Fed Chairman Ben S. Bernanke in outlining what his strategy would be should the ECB’s key interest rate fall close to zero or whether he’d pursue so-called “quantitative easing.”

He noted the bank had already cut rates at the fastest pace in its history and offered unlimited cash to the region’s banks. “If new decisions are needed we will take new decisions, but I can’t say anything else at this stage” he said. “We continue to look very carefully at the situation of the market and the situation of the economy.”

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