Brussels, 04/12/2008 (Agence Europe) - With its decision on Thursday 4 December to reduce interest rates in the euro area by 75 basis points, the European Central Bank (ECB) has taken a historic step. While a reduction was expected, its size is unheard of in the 10 years of the ECB. This decision, following on from two successive 50 basis point reductions in October and November (see EUROPE 9777 and 9757) reflects the seriousness of the economic situation and the fall in inflation. The interest rate for the main refinancing operations has dropped from 3.25% to 2.5%, while marginal lending facility and deposit facility interest rates have come down to 3% and 2% respectively.
Faced with economic recession, the drop in confidence indexes and, in particular, the significant slowdown in inflation, this “audacious” decision by the Governing Council was necessary, said ECB President Jean-Claude Trichet. After the meeting in Brussels, he restricted himself to saying that it was taken after agreement. He refused to indicate if other options (a reduction by 50 or 100 basis points) had been discussed, and did not wish to make any comment on the future intentions of the ECB. He had nothing to announce for January, he stated, opining that it was “exceptional” that the Bank had reduced its rates by 175 basis points in two months.
Clear reduction in inflation. “The evidence that inflationary pressures are diminishing further has increased” so that “inflation rates are expected to be in line with price stability over the policy-relevant horizon,” Trichet said. The inflation rate has been halved since summer, down to 2.1% in November from 3.2% and 4% in July. This drop in the rate of price increases “reflects the considerable easing in global commodity prices over the past few months, which more than offsets the impact of the sharp rise in unit labour costs in the first half of this year”. This fall was expected to continue, and perhaps even speed up towards the middle of next year, Trichet went on, stating immediately that inflation rates could rise once again thereafter and that any fall could be short-lived. According to ECB projections, price rises are likely to be between 3.2% and 3.4% for 2008, declining to between 1.1% and 1.7% for 2009 and between 1.5% and 2.1% for 2010 - substantially lower than prevision forecasts. While risks to price stability are “more balanced than in the past”, a reversal of the current trend on commodity markets and domestic price pressures could cause a rise. “It is, therefore, crucial that price and wage setters fully live up to their responsibilities,” Trichet said.
Economic activity will continue to weaken. “In the euro area, a number of downside risks to economic activity that were identified previously have materialised, leading in the third quarter to a contraction of 0.2% in real GDP growth,” Trichet stated. He went on to say that it was likely that “economic activity has weakened further during the fourth quarter of 2008”. Domestic demand was likely to remain sluggish over a prolonged period and the economic perspective remains bleak. This was confirmed by the ECB forecasts published the same day, which expect a rise in economic activity in 2008 (of between 0.8% and 1.2%), but foresee a fall in GDP next year (of somewhere between 1% and 0%). In 2010, growth is likely to be around 0.5% to 1.5%. These figures differ substantially from those given in September and there is still a very high degree of uncertainty surrounding them.
Supporting confidence. Maintaining budgetary discipline and the immediate implementation of measures by member states, including the recapitalisation of banks, were crucial for a sustainable recovery. Trichet again called for full application of the EU budgetary framework, with Stability and Growth Pact rules providing the necessary flexibility. “It is crucial that discipline and a medium-term perspective are maintained, taking fully into account the consequences of any shorter-term action on fiscal sustainability,” he hammered home. He stressed: “The significant measures announced by governments to deal with the financial turmoil should be implemented swiftly so as to help ensure trust in the financial system and to prevent constraints on credit supply to companies and households”. (A.B./transl.rt)