OECD: Euro zone to contract '09, room for ECB cuts

By Jan Strupczewski

BRUSSELS (Reuters) - There is room for more European Central Bank interest rate cuts in coming months as inflation falls rapidly and the economy is likely to shrink next year, the Organisation for Economic Cooperation and Development said.

The OECD revised down on Tuesday its growth forecast for the 15 countries using the euro to a contraction of 0.6 percent in 2009 from the previous, November 13 forecast of a 0.5 percent fall. The main reason behind the output fall is a drop in investment.

This year, euro zone growth is likely to be 1 percent, the OECD said, cutting the November 13 forecast by 0.1 percentage point. But the economy will rebound in 2010, it said forecasting growth of 1.2 percent.

The 2009 OECD growth forecast is similar to that of the International Monetary Fund's, but more pessimistic than the European Commission's prediction of a 0.1 percent expansion.

Euro zone inflation, which the ECB wants to keep below, but close to 2 percent, will fall to 1.4 percent next year from 3.4 percent seen this year and decelerate further to 1.3 percent in 2010, the OECD forecast, repeating its November 13 prediction.

"The prospective dampening of inflationary pressures over the next two years will provide scope for further reductions in policy rates in the coming months," the OECD said.

"Policy rates are projected to decline to 2 percent by next spring, and remain at that level for a year," it said.

The ECB cut interest rates by 0.5 percentage point in October and again in November to 3.25 percent and has signaled it could cut rates again on December 4. Many economists expect a cut of 50 to 75 basis points.

The OECD said that were financial conditions to deteriorate further, or activity to drop more rapidly than projected, deeper interest rate reductions could be necessary in the near term.

"Thereafter, with financial turmoil dissipating and economic activity turning up, modest increases in the policy rate appear appropriate to ensure inflation remains below 2 percent in the years ahead," the OECD said.

It forecast the unemployment rate would rise to 8.6 percent of the workforce in 2009 from 7.4 percent seen this year and increase to 9.0 percent in 2010.

The slowing economy will boost the budget deficit of the euro zone to 1.4 percent of gross domestic product this year from 0.6 percent in 2007 and the gap will rise to 2.2 percent in 2009 and 2.5 percent in 2010, the OECD said.

(Reporting by Jan Strupczewski, editing by Tony Austin)