Europe Economy

European Central Bank Urged to Cut Rates, but Will It?

The European Central Bank (ECB) has been urged by the International Monetary Fund (IMF) and various economic experts to slash the euro zone base rate as the European debt crisis threatened a second recession.

Jean-Claude Trichet
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But while there seemed little doubt that ECB president Jean Claude Trichet — who will chair his last governing council rate meeting ahead of the end of his eight-year term on October 31 — would signal a rate cut during the now obligatory press conference that follows the ECB rate decision, most analysts thought it unlikely the bank would act on Thursday.

At the heart of the ECB's problems is the fact that euro zone inflation jumped to 3 percent on the year in September from 2.5 percent in August and against the bank's target of 2 percent.

Even the news on Tuesday that falling energy costs pulled down producer prices in the euro zone marginally was considered unlikely to be enough to encourage the ECB to ease rates from their current 1.5 percent.

"The only mandate that the ECB has at this point is to really fight inflation. So if they stick to that mandate, I don’t see that they would lower the interest rates," Bruno Verstrate, CEO of Nautilus Invest told CNBC.

Most analysts now appear to accept it is a remote possibility that they would see a rate cut this month but, they say, the markets want to see ECB action sooner rather than later and a rate cut has already been priced in.

“We think the ECB should cut the base rate to 1 percent, admit the rate hikes earlier this year were an embarrassing mistake and that Trichet should shuffle off into the sunset,” said Jeremy Batstone-Carr, director of private client research at Charles Stanley.

“That is what we think should happen so anything we don’t get in that sense will be a disappointment to us and the markets I think given we now expect a recession in the EU,” Batstone-Carr said.

“Should they [ECB] cut interest rates? Well they need to do anything they can to promote growth but before they do that they need a coordinated growth policy across the entire 17 member euro zone,” Justin Urquhart Stewart, co-funder and director at Severn Investment Management, added.

Both analysts told that Trichet may wish to hold off the decision in order to allow his successor, current Italian central bank governor Mario Draghi, to decide on interest rates next month.

But Batstone-Carr saw this as a bad decision in light of the current economic crisis facing the euro zone and the threat of a second recession looming over Europe.

“I don’t see why there would be any reason for delay... it would have some impact in terms of helping the ECB to regain some credibility that it has lost over the last six months,” said Batstone-Carr.

“In terms of the interest rate decision, Trichet’s comments will be scrutinized very carefully if the ECB acts. But if he does nothing what he says won’t matter because it won’t be up to him in the future it will be up to Draghi and the market would do better to seek his views.”

Urquhart Stewart said whatever the ECB did with interest rates, such action alone was not the solution to the current economic crisis. He also argued that Trichet was right to put interest rates up earlier in the year.

“Growth has not stopped because we put interest rates up, it stopped because of the banking crisis,” he said.

“Interest rate policy is not going to be enough. We need new schemes such as a euro zone smaller business development fund. We need to invest in areas such as technology. European leaders need to be more imaginative and they need to look like they are really together rather than just saying they are.”