ECB Cuts Rate Less Than Forecast as Recession Deepens

By Gabi Thesing

April 2 (Bloomberg) -- The European Central Bank cut its benchmark interest rate less than economists forecast, reducing it by a quarter point to 1.25 percent, even as the euro-area economy sinks deeper into recession.

The decision by the Frankfurt-based ECB was predicted by just four of the 55 economists in a Bloomberg News survey. Forty-nine said the key lending rate would be lowered by a half point. The rate for overnight deposits at the central bank was cut to 0.25 percent from 0.5 percent.

“They’re playing with fire,” said David Kohl, deputy chief economist at Julius Baer Holding AG in Frankfurt. “They want to give a signal that they’re approaching the low point in rates and that’s why they’re choosing smaller steps.”

As rates edge closer to zero, officials are debating the merits of following the Federal Reserve and the Bank of England in buying assets. While Vice President Lucas Papademos says the ECB could purchase corporate debt, council members Juergen Stark and Axel Weber have signaled they’re opposed to such a move, suggesting the council is split on the scope of new measures.

The euro rose almost a cent against the dollar after today’s decision to $1.3422. It pared its drop versus the pound and gained against the yen.

Trichet holds a press conference at 2:30 p.m. He may face questions on whether the ECB will offer financial institutions longer-term loans after Papademos and three other officials said they may lengthen maturities from the current six-month limit.

Record Low

At 1.25 percent the main rate is the lowest since the ECB took charge of monetary policy in 1999.

“Today’s press conference will be the most eagerly awaited in a long time,” said Juergen Michels, chief euro region economist at Citigroup Inc in London. “Hopefully we will get an indication where policy will go from now on, but I doubt they’ll be ready to start on non-conventional measures before the summer.”

Today’s decision came as leaders from the Group of 20 nations met in London to discuss ways to rescue the global economy. The euro-region economy may shrink as much as 4.1 percent this year, faster than the ECB expects, according to the Organization for Economic Cooperation and Development.

Europe’s manufacturing industry contracted more than initially estimated in March and unemployment jumped to a three- year high of 8.5 percent February, reports yesterday showed.

Policy Shift?

Asset purchases would mark a shift for the ECB, which has stood aside as central banks in the U.S., the U.K. and Japan pump money into their economies by buying government and corporate debt after cutting their key rates to almost zero.

With 70 percent of the euro region’s corporate financing coming from banks, the ECB has so far focused on trying to revive interbank lending.

It loans banks unlimited amounts of cash for up to six months and has allowed its deposit rate to steer short-term market borrowing costs.

The ECB “is a different animal to all the other central banks, but has in fact be quite creative in terms of how it tackled the crisis,” said Astrid Schilo, an economist at HSBC Holdings Plc in London said.

Today’s smaller-than-forecast reduction may stoke speculation that the ECB hasn’t yet reached the end of its cutting cycle.

That in turn could delay the introduction of loans with longer maturities, said Ken Wattret, an economist at BNP Paribas in London. Banks won’t be tempted to borrow long term from the ECB if they think rates are set to fall further, he said.

“Longer maturities come with a snag.”

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