ECB, Bank of England slash rates

Bloomberg

Officials meeting in Frankfurt yesterday reduced the benchmark lending rate by half a percentage point to 1.5 percent. That’s the lowest since 1999. The economy of the 16 euro nations is shrinking faster than the ECB expected three months ago, as the crisis curbs export demand and companies lay off workers. ECB President Jean-Claude Trichet has been reluctant to follow the Federal Reserve and the Bank of England, which have cut rates toward zero, for fear that will sow the seeds of future crises.

Also yesterday, BoE reduced the benchmark interest rate to the lowest ever and said it would start purchasing 75 billion pounds ($105 billion) in assets, printing money to fight the recession. The bank’s nine-member panel, led by Governor Mervyn King, cut the rate a half point to 0.5 percent, the lowest since the bank was founded in 1694.

In a statement accompanying the decision, the bank said it may take up to three months to carry out the asset purchases. Most of the assets will be U.K. government bonds known as gilts. The bank will hold a open market operation today.

ECB council member Athanasios Orphanides has argued the bank could adopt similar measures to boost its economy, challenging Trichet’s view that they have "drawbacks" and should be avoided.

Uncharted waters

"We’re moving into a new world in the U.K. from interest-rate adjustment to quantitative easing," said Charles Goodhart, a former Bank of England policy maker. "It’s a great deal more uncertain how things will be done. This month what the Monetary Policy Committee says is going to be much more important than what they do."

The ECB has "misjudged the severity of the economic downturn," said Julian Callow, chief European economist at Barclays Capital in London. "The monetary policy stance of the ECB is delaying the recovery. We’re looking at 2012 to fully make up for the contraction of the economy."

The euro-region economy shrank 1.5 percent last quarter and latest data suggest the recession is deepening. Manufacturing contracted at a record pace last month, confidence is at an all-time low, unemployment is climbing toward 10 percent and inflation, at 1.1 percent, is the weakest since 1999.

ECB Council members Axel Weber and Christian Noyer said this week that the ECB is examining all its options, including the purchase of commercial paper. "We’ve not reached a conclusion," Weber said.

Speaking at a press conference in Frankfurt after the decision, ECB President Jean-Claude Trichet said inflation will stay "well below" his 2 percent ceiling this year and the next. "Overall, inflation rates have decreased significantly and are expected to remain well below 2 percent in 2009 and 2010," Trichet said. "That’s due to the fall in commodity prices and diminishing cost pressures reflecting the severe downturn in economic activity."

The ECB also cut its growth and inflation forecasts for the 16- nation euro region yesterday. The central bank expects the economy to contract between 3.2 percent and 2.2 percent this year after earlier forecasting a range of minus 1 percent to zero.

Next year, the ECB said the range will be between a contraction of 0.7 percent and growth of the same margin. "Overall, inflation rates have decreased significantly and are expected to remain well below 2 percent in 2009 and 2010," Trichet said. "That’s due to the fall in commodity prices and diminishing cost pressures reflecting the severe downturn in economic activity."