Falling European inflation to pave the way for rate cuts

Business Materials 28 November 2008 08:19 (UTC +04:00)

Inflation in the 15-member eurozone slipped to below 3 per cent for the first time in more than 12 months in November, data to be released Friday is forecast to show, paving the way for the European Central Bank (ECB) to deliver a hefty rate cut next week, dpa reported.

Analysts expect the European Union's statistics office to say annual inflation in the eurozone dropped from 3.2 per cent in October to 2.7 per cent this month as falling oil prices have undercut inflationary pressures.

This leaves eurozone inflation still above the ECB's two-per-cent target for annual inflation.

But leading ECB officials including bank chief Jean-Claude Trichet have signalled that the ECB's 21-head rate-setting council was gearing up to ease monetary policy further when it holds one of its regular-out-town meetings in Brussels next Thursday.

"The receding inflationary pressure has created ample room to move for European monetary policy, which will be also used given the rapidly deteriorating economic outlook," said Germany's Bundesbank chief and ECB council member Axel Weber in a recent speech.

Inflation hit a 16-year high of 4 per cent in June as oil prices headed towards a record of nearly 150 dollars a barrel. However, this month oil prices crashed to a 22-month low of under 50 dollars a barrel as a slowing world economy hit demand.

Coming amid signs that the global economic downturn is rapidly gaining momentum, analysts are predicting that the Frankfurt-based ECB will cut borrowing costs by 50 basis points to 2.75 per cent, which would be the lowest level in more than two years.

A cut next week would also be the third time in two months that the ECB has reduced the cost of money.

Next week's rate cut will coincide with the ECB unveiling its latest so-called staff projections, which are likely to revise down both economic growth and inflation forecasts for this year and 2009.

Moreover, some economists believe that the ECB will be forced to slash rates by 75 or even 100 points in a bid to spur growth in the eurozone.

"The risks to price stability are evaporating quickly," said ING economist Carsten Brzeski. "Now it's time for the ECB to take the plunge and cut rates further." Up until now, the ECB has preferred to make more modest changes to rates.

But a 75 or 100 basis-points cut next week would underscore the growing concerns about the European economy.

Economic sentiment in the eurozone tumbled to a 15-year low in November, a key survey released Thursday, after the eurozone tipped into recession in the third quarter.

Next Thursday's widely expected cut in eurozone rates follows the ECB's decision to deliver a 50-basis-points reduction at its meeting earlier this month. This brought the cost of borrowing down to 3.25 per cent.

However, the ECB is under pressure to go further than 50 basis points next week with the Bank of England announcing a dramatic 150- basis-point reduction earlier this month and Switzerland's normally conservative national bank chopping 100 basis points off rates. China this week announced a 108-point cut.