November 20, 2008 / 6:15 PM / 11 years ago

RPT-UPDATE 2-ECB signals rate cuts as recession questions remain

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By Marilyn Gerlach and Axel Bugge

LISBON, Nov 20 (Reuters) - European Central Bank officials added to expectations of further interest rates cuts on Thursday as unanswered questions about the severity and duration of the European recession took centre stage.

The 15-country euro zone was officially declared as in recession last week and analysts believe the ECB will continue to cut interest rates to dovetail with government stimulus packages and tax cuts and try and limit the damage to economy.

ECB Executive Board member Lorenzo Bini Smaghi, and Governing council members Axel Weber and Ewald Nowotny all added weight to the expectations saying that further rate cuts were possible.

“We have said it is a possibility. There may be more rate cuts, depending on the developments,” Bini Smaghi said in an interview with Portuguese newspaper Publico.

The same message also came from Weber, the head of Germany’s Bundesbank, who said the dramatic slowdown of economies in recent months and easing inflation meant the ECB had the scope to cut.

“A very pronounced slowdown of the European economy and many of the economies in rest of the world has given the monetary policy a certain room for manoeuvre... we will likely continue to use this room for manoeuvre.” he said in a speech at Euro Finance Week.

ECB interest rates are now at 3.25 percent after two 50 basis point cuts since October and analysts are betting heavily on another 50 basis point cut in December.

Governing Council Member Ewald Nowotny repeated his view that the ECB would cut rates again but played down the possibility of a bumper cut, admitting the central banks did not know how long the problems would last.

“Nobody I really think knows how deep this recession will go .... so therefore it makes perfect sense not to use all your firepower at once,” he told the Financial Times.

UNHAPPY COUPLE

Before the financial crisis policy makers had argued that the rapid development of emerging nations such as China, India, Russia and Brazil meant that the world was no longer so vulnerable when traditional global giants such as the U.S. and Europe fell into economic trouble.

Weber said that it was now clear that the opposite was true and the world’s economic system was even more interdependent.

He called for major nations to draw up a joint battle plan and re-opened the debate for coordinated interest rate action.

“I think what we’re facing here is a need for coordinated G-20 action, not just monetary policy in euro area economy or expansion of liquidity but having a very tight coordination also of the stand of monetary and fiscal policy at a global level.”

As policymakers try to prevent a major global recession the threat of deflation is also rising say economists.

Nowotny recently described it as the worst case scenario for the economy, however Bini Smaghi played down the threat. “We don’t anticipate a deflationary process happening,” he said.

While most analysts don’t expect deflation either many think inflation could drop as low 1 percent in the middle of next year as the recession bites, before climbing in the second half.

Bini Smaghi said inflation would continue to fall and that it was projected to be at the ECB’s targeted level of close to 2 percent in the next 18 months.

The key worry was to avoid interest rates remaining too low for too long, he said. Some economists have said easy monetary policy fed the easy credit that ultimately led to the financial collapse of the past few months.

“That is why we have a mid-term orientation in our policy and look at inflation developments, not month by month, but over the coming 18 months,” Bini Smaghi said. “In that, a reduction (in inflation) is projected to levels close to 2 percent.”

Asked whether the ECB has been too slow to cut interest rates in the past few months, he said nobody had expected an abrupt slowdown in the economy following the collapse of Lehman Brothers, and that inflation had been the major concern in the first half of the year.

“The truth is that now inflation is falling, partly due to the prices of imported products, but also because of the behaviour of domestic inflation,” he said. (Reporting by Axel Bugge and Marilyn Gerlach, writing by Marc Jones; editing by David Stamp)

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