ECB’s Weber Cautions Against Reducing Key Rate Below 2 Percent

By Simon Kennedy

Dec. 12 (Bloomberg) -- European Central Bank council member Axel Weber cautioned against reducing interest rates below 2 percent, becoming the latest ECB policy maker to signal the bank may be nearing the end of its rate-cutting cycle.

“If the benchmark rate sinks below 2 percent when medium to long-term inflation expectations are just below 2 percent, that implies negative real interest rates,” Weber said in an interview with Germany’s Boersen-Zeitung newspaper. “I would like to avoid that.” The Bundesbank, which Weber heads, confirmed the comments.

A week after lowering borrowing costs by 75 basis points, the biggest cut in the ECB’s history, officials are displaying little appetite to follow the Federal Reserve and other central banks in continuing to ease monetary policy aggressively. The ECB has pared its key rate by 175 basis points since early October to 2.5 percent.

“We should be cautious when our rates approach territory we haven’t explored before,” Weber said. “Our lowest level so far was 2 percent.” The euro rose more than half a cent to $1.34 after the comments were published late yesterday.

Federal Reserve officials have signaled they will lower their benchmark rate from 1 percent when they meet Dec. 15-16. The Swiss National Bank cut its key rate by half yesterday to 0.5 percent.

While Weber said the ECB has “further room to maneuver,” he questioned whether it will have enough new data by its Jan. 15 policy meeting to “re-evaluate the available monetary policy leeway.”

Pause in January?

“The risks are clearly growing that the ECB really does intend to pause in January,” said James Nixon, an economist at Societe Generale SA and former forecaster at the ECB.

Juergen Stark, an ECB executive board member, said Dec. 10 that the scope for further rate cuts is “very limited, potentially allowing for small steps only.” Council member Yves Mersch said last week that rate reductions of 25 basis points are more likely in future, and President Jean-Claude Trichet has said he wants to avoid being “trapped” by rates that are “too low.”

Weber echoed colleague Erkki Liikanen in saying that the ECB should “promptly normalize rates after the economic environment normalizes.” A lesson from the current crisis was that policy should have been “tightened sooner” in the previous expansion, he said. Liikanen said yesterday that the bank will have to raise rates “quickly” once a recovery begins.

Investors are still betting the ECB will lower rates by a further 50 basis points in January, Eonia forward contracts show. Economists at UniCredit Group yesterday changed their forecast and now predict the ECB’s benchmark will fall to 1 percent by June instead of bottoming out at 2 percent.

“Recent data only confirm the economy is heading for a sharp collapse and it’s hard to believe the ECB would pass up the opportunity to cut rates again in January,” Nixon said.

To contact the reporters on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net.