ECB to pause on interest rates as gloom deepens

The European Central Bank has made it very clear it will pause with cuts in interest rates on Thursday, focussing financial markets on signals of how low the bank can go and the likely scale of a cut they now expect in March.
ECB President Jean-Claude Trichet has said the next important policy meeting for the rate-setting council is not till next month, prompting analysts to virtually abandon hopes of a cut this week despite an ever gloomier economic backdrop.
Trichet and others have underlined the dangers of cutting rates to zero and, as recession engulfs much of the euro zone, economists say the bank will also need to explain clearly that it is not behind the curve.
"If they actually decided to cut rates immediately, that would be interpreted as a sign of emergency," said Bank of America economist Gilles Moec.
"It would indicate they are really scared and that is probably not the message they want to send right now. I would expect them to indicate even more clearly that we should expect something in March, and expect something quite significant." All but 3 analysts in a Reuters poll of 85 economists expected the ECB to keep base borrowing costs at 2 percent on Feb. 5 after a 50 basis point cut at the Jan. 15 meeting.
But the same majority expected the bank to cut its headline rate in March, with most backing it to go to a record-low of 1.5 percent, before easing credit costs further to 1 percent by the end of June, where they would remain well into next year.
Goldman Sachs said on Monday it now sees rates going as low as 0.5 percent by the third quarter, changing its earlier forecast of rates to trough at 1.5 percent, after ECB Governing Council member Athanasios Orphanides said forceful action might be needed.
Still, other policymakers have been at pains to play down the chances of rates going as low as those in the United States and Japan.
Economists will look to post-meeting comments for signs of what the floor is if zero rates are not on the cards, and seek any sign that the ECB may follow the U.S. Federal Reserve in directly buying assets.
"I think the ECB does not want to bring the real rate into negative territory," Royal Bank of Scotland economist Jacques Cailloux said. "If you use short-term inflation expectations, you still have room for cutting the rate."
BELEAGURED ECONOMY
Many economists expect inflation to completely stall or even turn negative, but many ECB policymakers have dismissed the risk of deflation in the 16-country bloc and Trichet said last month the ECB saw risks in the medium-term as broadly balanced.
Yet inflation in the euro zone is falling faster than expected and plunged to 1.1 percent annually in January, the lowest in almost 10 years and well below the ECB's target of below, but close to, 2 percent.
Euro zone countries have also provided a bevy of weak economic data since the January meeting.
Unemployment rose in December to 8 percent — above forecasts and its highest since November 2006; November industrial new orders fell 26.2 percent year-on-year — the biggest fall on record — and economic sentiment fell to the lowest since records began in 1985.
Loans to euro-zone firms and households fell in December for the first time in the ECB's 10-year history, adding to arguments for lower rates and raising the risk that consumer and corporate spending has further to fall.
Money supply growth, a key indicator of price pressures for the ECB, also slowed more than expected.
The ECB will unveil new inflation and growth forecasts from central bank staff in conjunction with its March meeting.
Consumer and business inflation expectations have dropped and market expectations, drawn from the yields on index-linked bonds, have fallen to between 1 and 1.5 percent over a 4-8 year horizon.
"Looking at the state of the economy, it probably warrants another rate cut as early as this week," Cailloux said. "They will go for another cut when they publish newly downward revised estimates."
But even with low inflation expectations, Governing Council members have indicated the ECB would not follow the U.S. Fed and the Bank of Japan in cutting rates to zero.
And with little room to cut rates, analysts are starting to look what else central banks have in store, especially whether ECB would start to directly buy corporate debt.
"The real debate inside the ECB is not really about the interest rates, the real debate is whether the ECB will have to go to non-conventional measures," Natixis Chief Economist Patrick Artus said.