ECB Set to Cut Rates to New Low; QE in Focus

The European Central Bank is set to cut interest rates on Thursday to a new all-time low of 1.0 percent, in what could be its last move for some time, and to fire a salvo of longer-term funding at commercial banks.

It is also likely to lower its overnight deposit rate — the rate currently setting the bar in money markets — by a smaller amount to avoid driving interbank interest rates to zero.

Economists are also eager to hear if policymakers are any closer to following the U.S. Federal Reserve, Bank of Japan and Bank of England into quantitative easing, although expectations remain low.

ECB Governing Council members began their meeting at 8 a.m. London time as scheduled, and the vast majority of analysts polled by Reuters expect them to cut the main refi rate by another 50 basis points when it announces its decision at 12:45 p.m. London time.

But with money market rates now steered by the overnight deposit rate, focus is now just as much on that.

"We expect 50 basis points from the policy rate and 25 basis points from the deposit rate," said Goldman Sachs economist Erik Nielsen.

The overnight deposit rate is currently only 0.5 percent so a more modest 25 basis point cut would leave it just above zero.

Like many economists, Nielsen also tipped the ECB to extend the maximum maturity of loans to commercial banks to a year from six months now.

Cutting the refi rate to 1.0 percent and the deposit rate to just 0.25 percent would narrow the ECB's rate corridor to 75 basis points from 100.

The ECB tried a similar approach late last year and then abandoned this after banks stashed billions of euros in its overnight account, rather than lending the money on into the commercial banking system.

But analysts argue banks would be unlikely to do that again, especially if the ECB extends the maturity of its tenders.

The ECB has already cut its benchmark rate five times from 4.25 percent since last October as the 16-country economy has gone from bad to worse.

AP

The latest economic data have shown little sign of a let up in the recession, while annual inflation hit a record low of 0.6 percent in March and is expected to fall further.

Governing Council member Athanasios Orphanides said inflation was expected to be below the ECB's 2 percent ceiling due to negative economic developments.

Economic forecasts have continued to be slashed and policymakers are still feeling in the dark to pinpoint an end to the global financial crisis.

Euro zone unemployment jumped more than expected in February to 8.5 percent, while the Organisation for Economic Cooperation and Development warned this week it could reach almost 12 percent in 2010.

The OECD also predicted the economy would shrink 4.1 percent this year, far more that the ECB's current worst case scenario of 3.2 percent, and lending data now show banks are reducing the supply of loans to firms and consumers.

Laying a Floor

Policymakers have delivered a steady stream of hints over the last few weeks that they will cut rates to 1 percent, but they still appear split on whether that will mark the lowest point.

The Reuters poll showed most analysts think the ECB will leave rates at 1.0 percent until the end of 2010.

However, 23 of the 76 asked predicted rates will be below that level come September.

Mcihael Probst / AP

"The ECB may signal that the floor has been reached, given that several Governing Council members had previously named 1 percent as an absolute floor," said Nomura analyst Laurent Bilke, referring to comments from Bundesbank chief Axel Weber. "Alternatively it may stress a lot has been done already, which would support the case for the next move, if any, being a 25 basis point rate cut."

He also questioned whether the President Jean-Claude Trichet would provide any clues that the ECB is edging towards quantitative easing measures — printing money — in his news conference at 1:30 p.m. London time.

"(Buying) corporate bonds, commercial paper or asset-backed securities have been mentioned. This seems to be advocated by the ECB Vice President (Lucas Papademos) but we doubt that all the governors have embraced the idea yet," said Bilke.

Goldman's Nielsen agreed.

"I don't expect them to say too much more on quantitative easing. They will say that all options are on the table but nothing more concrete than that."

"I don't there is a big need right now; they should get ready for it but there is also the fact there is very little they can actually buy," he said referring to laws that stop the ECB from buying debt directly from governments.

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