ECB set for rate cut as inflation falls sharply

Wednesday, May 1st, 2013 | Finance News

By Eva Kuehnen

FRANKFURT (Reuters) - The European Central Bank is expected to cut its main interest rate for the first time in 10 months on Thursday, driven to act by an economy wallowing in recession and freed to do so by sharply falling inflation

Economic data over the past weeks since ECB President Mario Draghi said the bank stood ready to act if necessary has shown growth prospects darkening.

Unemployment hit a record high in April. Inflation had its biggest monthly drop more than four years, to 1.2 percent, well below the banks target of 2 percent or slightly below.

"If the ECB does hold fire on interest rates next Thursday, it is very likely only delaying the inevitable," said Howard Archer, European economist at IHS Global Insight.

ECB Vice-President Vitor Constancio last week said there was still room to cut interest rates, reiterating the bank's readiness to act should the economy deteriorate further, which he said had been unfortunately the case.

A Reuters poll of 76 economists taken last week - before the inflation data - saw a slim majority forecasting a 25-basis point cut from the current 0.75 percent, while only half of the 22 euro money market dealers polled by Reuters expect such a step.

But the economic impact is questionable and not everybody is in favor of another cut. German Chancellor Angela Merkel said last week the ECB would have to raise interest rates if it were looking at Germany alone.

German insurers and the county's dominant savings and cooperative banking sector have also joined up to speak out against looser ECB monetary policy, saying it would have little economic impact and undermined savings needed to protect the country's rapidly ageing population.

The euro zone periphery countries take the opposite view.

"Mr Draghi has been very good with words since the summer, but now it is really time to deliver accommodative policy in the periphery of the euro area," said Anna Maria Grimaldi, European economist at Italian bank Intesa Sanpaolo. She sees a potential for the ECB to cut rates by 50 basis points on Thursday.

SMALL COMPANIES, BIG PROBLEM

The euro zone's south is not benefiting to the same extent as the north from ultra-low rates. Banks there are charging companies and households more for loans than their peers in the north because of higher funding costs and credit risks.

The ECB has repeatedly voiced its concern about the impact this has on lending to small- and medium-sized enterprises (SMEs), which have little alternative to bank funding and are a key engine for growth in the currency bloc.

It has said it is studying options to address the problem, but little is expected to be decided at Thursday's policy meeting that is taking place in Bratislava. It is one out of two policy meetings the ECB holds outside of Frankfurt each year.

"We suspect that the ECB will avoid making any formal statement on a potential SME program ... as it continues to weigh the pros and cons of such measures," said Frederik Ducrozet, senior euro zone economist at Crédit Agricole CIB.

(Reporting by Eva Kuehnen, additional reporting Jonathan Gould. Editing by Jeremy Gaunt.)

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