ECB cuts rates to record 1.5%, mulls radical action


By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, March 5, 2009

The European Central Bank has cut interest rates a half point to an historic low of 1.5 percent and opened the door for extreme measures akin to the quantitative easing(QE) under way in America, Britain, and Japan.

"I don't exclude anything," said Jean-Claude Trichet, the ECB's president. "We did not decide that this is the lowest level. We are studying additional non-standard measures." Bond yields plummeted across the eurozone as the markets instantly priced in further monetary loosening.

None of the eurozone's 16 central banks have ever seen interest rates this low. The cut follows a collapse in industrial production over the last five months. The pace of deterioration has been faster than the early 1930s, when falls were mostly stretched over a longer period.

The ECB has torn up its growth forecast for this year and expects an unprecedented contraction 2.7 percent for the eurozone. Even this may prove optimistic. Output fell 1.5 percent in the fourth quarter and the picture seems to be going from bad to worse. Export orders for German engineering companies fell 47 percent in January.

Julian Callow from Barclays Capital said the ECB had responded too slowly over recent months as credit tightened. Rates should be "minus 1 percent" under a "Taylor Rule" analysis of economic conditions, suggesting the bank is still far behind the curve. "They need to move urgently. The euro area is besieged by sharply rising unemployment. This is going to a scourge over coming years, with the jobless rating rising to a postwar high of 11 percent," he said.

The Handelsblatt's "shadow ECB" of economists from across Europe voted for more drastic action. "I can see no reason for delaying rate cuts to the minimum and moving quickly to quantitative easing (QE)," said Erik Nielsen from Goldman Sachs. He slammed ECB hardliners for clinging to "Voodoo" theories.

Mr Trichet said the ECB had cut its deposit rate to 0.5 percent -- bringing down the market Eonia rate in lockstep -- and was providing unlimited liquidity to banks. "This is of great importance," he said.

The ECB has boosted its balance sheet to E600 billion by lending freely but appears deeply reluctant to escalate to QE by purchasing bonds and other assets -- although the German and French governors have both hinted at ECB purchases of commercial paper.

Mr Trichet said there is no hurry because "the risks of deflation are very meagre" -- though CPI inflation may turn briefly negative by mid-year. Deflation expectations are not becoming embedded, he said. Critics retort that is that once they are embedded, it is already too late to arrest the downward spiral. This is why other central banks are taking pre-emptive steps.

The suspicion is that a German led bloc of ECB hawks are dragging their feet in part because QE measures would blur the lines between the bank and the fiscal authorities. This risks opening a can of worms in euroland where there is no single treasury. ECB bond purchases would be tantamount to the creation of an EU debt union. This is a huge political step, and anathema to Berlin.

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