December 8, 2008 / 3:03 PM / 11 years ago

WRAPUP 2-ECB has lots of room for more rate cuts-policymakers

(Adds Trichet comments in paragraphs 6 and 14-16)

By Michele Kambas and George Georgiopoulos

NICOSIA/ATHENS, Dec 8 (Reuters) - The European Central Bank has plenty of room to lower interest rates further even after last week’s record 75 basis point cut, ECB policymakers said on Monday.

Athanasios Orphanides, head of the Cyprus central bank and an ECB Governing Council member, said the euro zone economy was set for an extended downturn and inflation would keep falling.

“In light of the continuing improvement in the outlook for inflation, even following last week’s interest rate action by the Governing Council there remains considerable room for monetary policy to manoeuvre,” he told the Cyprus parliament’s finance committee.

But he told Reuters after the hearing that no options could be excluded, including a pause in interest rate moves in the short term if economic data showed this was appropriate.

“I would not rule out any possibility if the data which exists in the next 1-2 sessions means that it would be prudent to take further decisions,” he said, when asked about a possible pause to allow markets to digest a 175 basis point reduction in euro zone borrowing costs in the last two months.

ECB President Jean-Claude Trichet, in testimony on Monday to the European Parliament’s economic committee, said unexpected further declines in commodity prices could put downward pressure on inflation, while upside risks to price stability could materialise if the fall in commodity prices were to reverse.”

The Governing Council — which decides monetary policy monthly — cut rates last Thursday for the third time since October to a 2-1/2-year low of 2.5 percent. Economists expect another cut in January due to growing evidence of a severe recession.

Luxembourg’s Yves Mersch said last week that he expected a pause after Thursday’s move — the biggest ever by the ECB — and Austria’s Ewald Nowotny said it was in wait-and-see mode.

Orphanides’s Greek counterpart, George Provopoulos, said on Monday that the ECB has enough monetary tools. “There is no issue when it comes to lack of ammunition. The ECB has ample monetary policy ammunition,” he told the British-Hellenic Chamber of Commerce.

Nowotny told Bloomberg news agency that the ECB is keeping its options open on interest rates and does not want to be pressured by expectations.

“The situation is open,” he said. “We’ll observe how things are working, what’s happening, and then we’ll see. The ECB certainly doesn’t want to be pressured by expectations.”

“I favour a steady-hand policy. Having said that, one should always retain the flexibility to react to new developments. There’s certainly room for manoeuvre if the future economic development is significantly weaker,” he said.

ECB staff drastically revised down their forecasts for euro zone GDP and inflation on Thursday. These showed the region’s economy would contract in 2009 and inflation would average around 1.4 percent, undershooting the ECB’s price objective of below but close to 2 percent.

In his testimony at the European Parliament, Trichet said global weakness and very sluggish domestic demand are expected in the last quarter of this year and in the next few quarters.

Economic recovery should gradually take place, supported by a decline in commodity prices, while the external environment improves and financial tensions weaken, he added.

“With lower commodity prices and weakening demand, annual inflation is expected to be in line with price stability over the policy-relevant horizon,” Trichet said.

Orphanides told Reuters that deflation might stalk the euro zone “for some months” in 2009, largely due to the fall in oil prices. “But that (deflation) is not something that should concern us” because it would not ravage the region the way it had hit certain economies in the 1930s and Japan in the 1990s.

“Specifically the price of crude climbed high in the summer. Since then the prices have fallen significantly. If we see a further decline in prices which were at very high levels then we may see this phenomenon of deflation,” he said.

Orphanides said that if the ECB were successful in keeping inflationary expectations in check, that would give the bank flexibility in dealing with the economic slowdown. (Writing by Marilyn Gerlach; editing by Stephen Nisbet)

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