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Credit squeeze induces ECB to avoid rate increase

Section: Daily Dispatches

By Ralph Atkins
Financial Times, London
Thursday, October 4, 2007

The credit turbulence that began in the US mortgage market put European policymakers on the spot on Thursday as the European Central Bank all but dropped plans for an interest rate rise and the Bank of England decided to leave its main rate unchanged.

Speaking after the ECB held its main interest rate at 4 per cent at a meeting in Vienna, Jean-Claude Trichet, president, went further in stressing the downside risks to growth in the eurozone.

Although the ECB would not let up in the battle against inflation, significant changes in the wording of Mr Trichet's statement hinted strongly that the central bank saw little case for further rises in borrowing costs. Before the credit squeeze, the ECB had been planning to raise interest rates last month.

The Bank of England left rates on hold at 5.75 per cent, opting to take more time to assess the implications of the credit squeeze for growth and inflation. Its decision to stay its hand had been expected, as had that of the ECB.

As the central banks made their move, Alistair Darling, UK chancellor, told the Financial Times in an interview that Britain was heading for an economic slowdown after being buffeted by the global credit squeeze.

The chancellor is expected to downgrade his 2.5-3.0 per cent growth forecast for 2008 when he presents his spending review and pre-budget report to the House of Commons, probably on Monday.

Economists believe increasingly that UK and eurozone interest rates have peaked, after a series of tightening moves in the past year. The chances of an early cut in the UK were growing, analysts said.

Financial markets have also started talking about a fall in eurozone borrowing costs next year. But Holger Schmieding, economist at Bank of America, said: "It would probably take a dramatic, protracted and wholly unexpected downturn in the economic data to trigger any rate cut discussion in Frankfurt."

The ECB's task has been complicated because inflation in the 13-country region has started to rise and is expected to stay above its target of an annual rate "below but close" to 2 percent well into next year. But recent economic data have also pointed to a marked slowdown in economic growth, almost certainly exacerbated by the global credit squeeze and a stronger euro.

Mr Trichet insisted that the ECB would act swiftly if necessary to make sure expectations about future inflation trends remained "anchored." Among downside risks to eurozone growth was the potential impact of financial market turmoil on confidence and financing costs.

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