Markets brace for big European rate cuts


By Chris Giles, Ralph Atkins, and Joanna Chung
Financial Times, London
Wednesday, December 3, 2008

Financial markets are braced for large interest rate cuts across Europe on Thursday amid mounting evidence of a sharp slowdown in the leading global economies.

In the eurozone, traders priced in a 0.75 percentage-point reduction by the European Central Bank to 2.5 per cent on Thursday, a move that would be bigger than any it has made in its near 10-year existence. Although economists were a little more cautious, with inflation risks disappearing fast, they nevertheless believed a three-quarter percentage point reduction was a distinct possibility.

In the UK, the consensus among economists shifted this week to an expectation that the Bank of England would cut its rate another percentage point to 2 per cent, equal to its lowest rate since the Bank was founded in 1694. The overnight index swap market, one of the best guides to official interest rate expectations, has priced in a cut of 1.5 percentage points.

Influential voices are calling on central banks to be bold. Willem Buiter of the London School of Economics, a former member of the Bank of England's monetary policy committee and chief economist of the European Bank for Reconstruction and Development, said the recession in advanced economies is "going to be so deep and so prolonged" that zero per cent rates "will be reached even by the most anal-retentive gradualist central bank before the middle of 2009."

In the US, new data showed that service industries contracted by the biggest margin on record in November while large companies announced 181,671 layoffs during the month -- the most in almost seven years.

In addition, the Federal Reserve's Beige Book, which offers a picture of the economy based on anecdotal evidence provided to the US central bank, showed that "overall economic activity weakened" across all 12 Fed districts since the last report in mid-October.

The Fed report, based on data collected before November 24, said consumer spending fell across the US, with vehicle sales "down significantly" in most regions. Manufacturing activity "declined noticeably" in most areas, and almost all regions reported falling exports.

Meanwhile, the eurozone revised purchasing managers' indices showed service-sector output contracting at the fastest rate since the surveys began in mid-1998.

"There is still no sign of the downturn bottoming out," said Chris Williamson, chief economist at Markit, which produces the survey.

Sweden's Riksbank said this week it was bringing forward to today its latest interest rate announcement -- sparking talk that it would cut the policy interest rate by a percentage point.

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