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ECB expected to lower growth forecasts, not rates

It faces dilemma as a rate cut could aggravate euro zone’s high inflation

FRANKFURT – THE European Central Bank (ECB) will make a cut of sorts this week – but with euro zone inflation stubbornly high, the cut will be in its growth estimates, not interest rates, said economists.

‘The ECB council will cut on Thursday its forecasts for growth in the euro zone, but not its main interest rate,’ said WestLB economist Holger Sandte, making a prediction widely shared by other experts.

The United States Federal Reserve has cut rates in recent weeks in an effort to stave off a recession, and increasing signs of a slowdown in the euro zone are adding to pressure on the ECB to follow suit.

More pessimism was generated last Friday by a sharper- than-feared fall in the European Commission’s euro zone economic sentiment indicator to its lowest level in two years.

‘What is a worry is the sharp collapse in euro zone economic confidence over the last year. This is consistent with euro zone growth dropping well below 2 per cent this year, possibly to around 1.5 per cent,’ said Bear Stearns economist David Brown.

‘The ECB is now under huge moral pressure to cut rates, especially with the euro on a surge towards US$1.55,’ he added.

But another data release last Friday showed the dilemma that ECB head Jean-Claude Trichet faces – that of stubbornly high inflation, something which a cut in rates could exacerbate.

Euro zone inflation clocked in at 3.2 per cent in January, the highest level since the launch of the euro single currency in 1999. The number was worse than expected and was well above the ECB’s preferred level of inflation of close to but less than 2 per cent.

But slowing growth is expected to dilute inflationary pressures, which in turn should allow the ECB to cut rates later this year, economists believe.

‘Under these conditions, the ECB could start cutting interest rates in spring’ and gradually lower its main lending rate to 3 per cent by the end of the year from 4 per cent currently, said BNP Paribas economist Clemente De Lucia.

Source: AGENCE FRANCE-PRESSE (The Straits Times 3 Mar 08)

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