UPDATE 3-ECB surprises with rate cut, sees "mild recession"

Thu Nov 3, 2011 10:18am EDT

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By Paul Carrel

FRANKFURT Nov 3 (Reuters) - The European Central Bank cut interest rates by a quarter point to 1.25 percent in a surprise move on Thursday and President Mario Draghi said the euro zone could subside into a "mild recession" in the latter part of 2011.

The Italian has walked into a maelstrom in his first week at the ECB's helm, with euro zone leaders contemplating a future without Greece and economic policy paralysis in his home country threatening to pitch Rome into the storm.

But he offered no commitment to scale up the central bank's bond-buying programme to support the likes of Italy and Spain.

"What we are observing now is ... slow growth heading towards a mild recession by year-end," Draghi told a news conference.

"A significant downward revision to forecasts and projections for average real GDP growth in 2012 (are) very likely," he added.

The rate cut gave a modest boost to stock markets. The FTSEurofirst 300 index of top European shares was up 1.3 percent at 1400 GMT.

The decision to cut rates came despite inflation in the 17-country euro zone staying at 3.0 percent for a second month running in October, well above the ECB's target of just below 2 percent.

Draghi said the ECB expected inflation to subside below 2 percent next year.

"What a starter. It is obvious that the ECB has caught the crisis virus and is trying everything it can to prevent a full-fledged recession," ING economist Carsten Brzeski said.

European leaders said earlier they were prepared for Greece to leave the euro zone to preserve their 12-year-old single currency if Athens does not decide quickly to implement a bailout programme, putting the likes of Italy and Spain, and even France, firmly in the markets' sights.

Draghi will join the leaders in Cannes, France, after his debut news conference as ECB chief.

Europe's ultimatum to Greece, after Prime Minister George Papandreou's decision to call a referendum on a bailout plan, has deepened the crisis and raised pressure on the ECB, which many analysts see as the only institution with the firepower to bring calm.

NO SHIFT ON BOND BUYING

Draghi gave no hint that the ECB's bond-buy programme, a controversial tool that has led to the resignation of two German policymakers, would be accelerated despite the chaos in Greece threatening to engulf the much larger economies of Italy and Spain.

"Our securities market programme has three characteristics: it is temporary; it is limited; it is justified in restoring the functioning of monetary transmission channels," he said.

Draghi succeeded France's Jean-Claude Trichet as ECB chief on Tuesday -- a day that saw the ECB buy Spanish and Italian bonds but barely manage to cap a rise in yields on the debt of the euro zone's third largest economy.

He must balance an eagerness to curry favour with the German contingent at the ECB against growing financial market pressure to intervene on a bigger scale to lower the borrowing costs of Italy and Spain.

The premiums investors have to pay to hold Italian and French 10-year government debt over benchmark German Bunds rose to their highest in the euro on Thursday with signs growing that the Greek government may fall.

Trichet had signalled previously that the ECB was keen to withdraw from the bond-buying policy once the euro zone's EFSF rescue fund gained new powers to intervene on bond markets.

Draghi said the ECB was "closely monitoring" developments in Greece.

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