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Business

Europe Moves Towards Cutting Interest Rates Again

Europe's two leading central banks are expected to move this week towards lowering interest rates as inflation dwindles and economic growth spirals down.

Otmar Hoerl's euro sculpture in front of the European Central Bank in Frankfurt

The ECB is expected to slash rates again in March

While the Bank of England (BoE) meeting in London is forecast to announce a hefty 50-basis points cut in borrowing costs on Thursday, the European Central Bank (ECB) gathering in Frankfurt is likely to lay the ground for another rate reduction at its meeting in March.

"The next important meeting is in March," ECB chief Jean-Claude Trichet said at his press conference last month after the bank brought down the cost of money in the 16-member euro zone to 2 percent by delivering a 50-basis points cut.

"The message from Trichet is clear enough," said Dresdner Kleinwort senior economist Rainer Guntermann.

"They will do nothing in February," he said, with the ECB instead keen to assess the economic impact of the 225 basis points rate reductions it has delivered since October last year.

The ECB's meeting in March would also coincide with the release of the bank's latest so-called staff projections, which will set out the new economic growth and inflation forecasts.

Rates may continue to drop

Thursday's widely tipped cut in borrowing costs in Britain will bring rates in the European Union's second biggest economy down to 1 percent.

Economists believe that more cuts are in the pipeline as the BoE's nine-member monetary committee (MPC) moves again to try to spur economic growth in the country.

"The intensity of the current downturn, in particular the 1.5-percent drop in GDP, leaves little doubt in our minds that interest rates will continue to come down," said Philip Shaw of the investment house Investec.

Annual inflation in Britain edged down to 3.1 percent in December with the nation's economy having shrunk by a sharp 1.5 percent in the fourth quarter last year and unemployment surging to a near 12-year high.

Moreover, said Shaw, with the risk of credit flows drying up, "it is easy to envisage rates falling close to zero and the MPC requesting the mandate from the Chancellor (of the Exchequer) to provide further stimulus via quantitative easing."

British interest rates are already at their lowest level in history with the MPC having steadily slashed rates from 5 percent at the start of October to 1.5 percent in the hope of staving off the worst of the recession since 1980.

IMF sees slowdown for euro zone

The International Monetary Fund predicts the British economy will contract by 2.8 percent in 2008 and euro zone economic growth will slump by 2 percent in the wake of an economic slowdown triggered by a crisis in the US banking business.

A worker in protective clothing stokes a furnace

Just how much can interest rate cuts stoke Europe's economy?

At the same time, annual euro zone inflation dropped to its lowest level in about a decade in January, tumbling more than forecast to 1.1 percent on the back of falling oil prices and a slowing economy, as a result increasing the pressure on the ECB to press on with its rate-cutting cycle.

Meanwhile, euro zone unemployment climbed to its highest level in more than two years of 8 percent in December as companies cut production and laid off workers across the currency bloc.

"The prospects for considerable labor market slack and its dampening impact on wage-induced inflationary pressure means that the ECB's monetary easing work is not yet finished," said ING economist Martin van Vliet.

Economists believe that a steady stream of grim euro zone economic data will force the ECB to continue trimming rates in the coming months.

"They don't want to cut rates aggressively," said Guntermann, with analysts speculating whether the notoriously cautious ECB will limit the March rate cut to 25 basis points or deliver another 50 basis points reduction.

Hopes rise for end-of-year upswing

This is particularly the case as an unexpected rise in a recent slew of key economic sentiment surveys have helped to raise hopes that the round of rate cuts combined with government stimulus plans will result in a pickup in the European economy later in the year.

This has helped strengthen the hand of the hawkish members of the ECB's 22-head rate-setting council who have been arguing for a more guarded approach to easing monetary policy.

But going forward, analysts are divided about how far the ECB will be prepared to go in trimming rates.

While some believe that the ECB's benchmark rate could be at 1 percent or even 0.5 percent by around the middle of the year, others are predicting that the bank will bring the current rate-cutting cycle to an end at 1.50 percent.

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