Nowotny Says ECB ‘Cautious,’ January Cut Not Certain

By Christian Vits

Dec. 8 (Bloomberg) -- European Central Bank council member Ewald Nowotny said the bank is in a wait-and-see mode, signaling it won’t necessarily cut interest rates again next month.

“The situation is open,” Nowotny said in an interview in Wuerzburg, Germany, late on Dec. 5. “We’ll observe how things are working, what’s happening, and then we’ll see. The ECB certainly doesn’t want to be pressured by expectations.”

Investors are betting the deepening economic downturn will prompt the ECB to cut its benchmark rate by a further 50 basis points at its next meeting on Jan. 15, Eonia forward contracts show. The ECB lowered the rate by 75 points to 2.5 percent last week, the biggest reduction in its ten-year history. Still, President Jean-Claude Trichet refused to be drawn on whether it would lower borrowing costs again.

“We’ve taken this step, which was a relatively big one for the ECB, and we’ll monitor further developments,” said Nowotny, who heads Austria’s central bank. “I favor a steady-hand policy. Having said that, one should always retain the flexibility to react to new developments. There’s certainly room for maneuver if the future economic development is significantly weaker” than expected.

“The remarks point to a pause in January,” said Juergen Michels, an economist at Citigroup Inc. in London. “However, the ECB will cut rates again in February as the bank’s view on economic growth next year will turn out to be too optimistic.”

Downside Risks

The ECB last week predicted the economy will shrink about 0.5 percent next year, which would be its first full-year contraction since 1993. The 15-nation euro region is already in recession after the global financial crisis pushed up lending costs and damped demand for European exports.

“To my mind, the downside risks are probably bigger than the upside risks,” said Nowotny, 64. Still, “the ECB is rather cautious with interest-rate cuts and doesn’t want to commit hastily to anything.” Asked if the bank is in a wait-and-see mode, Nowotny said “yes.”

While the ECB expects inflation to drop below its 2 percent limit next year and stay there through 2010, it hasn’t achieved its price-stability goal since 1999. The ECB raised rates as recently has July, citing the threat of a wage-price spiral.

Trichet said last week he wants to avoid “being trapped” at interest-rate levels that are “too low.”

Global Rate Cuts

The U.S. Federal Reserve has reduced its key rate by 325 points this year to 1 percent, and the Bank of England has lopped 2.5 percentage points off borrowing costs since Nov. 6, taking its main rate to 2 percent.

The ECB has lowered rates by 175 basis points since early October and flooded the banking system with additional liquidity. Nowotny suggested policy makers want to take stock before committing to further steps.

“There’s uncertainty regarding the extent to which the measures taken this quarter are starting to have an impact,” he said. “We’re in uncharted waters but we see several indications that the situation is normalizing. Money-market rates are declining, they’re moving to the right direction, even though only slowly.”

Nowotny said the ECB may look at ways to make the use of the bank’s deposit facility “less attractive” to commercial banks. Overnight deposits with the central bank have boomed as financial institutions choose to park money with the ECB rather than risk lending to others at a better rate.

Banks deposited 250.5 billion euros ($322 billion) on Dec. 5, the ECB said today. In the year to Sept. 15, deposits with the ECB averaged just 534 million euros a day.

‘More Clarity’

“If this development continues and the deposit facility continues to be used exceptionally, we’ll have to look at it,” Nowotny said. The interest-rate corridor “mustn’t necessarily be symmetrical. But first of all, we have to see how things evolve after the interest-rate cut.”

Lending between banks ran dry after Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, shattering confidence and sending borrowing costs to records. The ECB has provided banks with unlimited cash in its weekly refinancing operations to rebuild confidence in the market and revive lending.

“After the closing of the balance sheets this year we’ll hopefully have more clarity and therefore more certainty,” Nowotny said. “The ECB has acted in a very expansionary way and against this background it’s wrong to assess the ECB’s policy as restrictive.”

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