ECB cuts rates to 2.5% and mulls 'printing money'

By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, December 4, 2008

http://www.telegraph.co.uk/finance/economics/interestrates/3551387/ECB-c...

The European Central Bank has slashed interest rates by three-quarters of a point to 2.5 percent in the boldest move since the launch of monetary union and hinted at revolutionary action to head off a severe slump next year as the economic crisis ravages the car, steel, and machine tool industries.

"Tensions have increasingly spilled over from the financial sector to the real economy," Jean-Claude Trichet, the ECB's president, said. He added: "Global and euro-area demand are likely to be dampened for a protracted period of time."

Sweden's Riksbank went even further, stunning the markets with a cut of 175 basis points to 2 percent. The Swedish authorities are deeply alarmed by the collapse of vehicle sales at Volvo, as well as the large exposure of Swedish banks to the property crash in Eastern Europe

"We're moving towards a world of zero rates in Europe and the G10 countries, perhaps as soon as the second half of next year," said Michael Klawitter, a strategist at Dresdner Kleinwort.

Mr Trichet said the eurozone is likely to contract by 0.5 percent next year amid a "hardening" of the credit markets. This is a dramatic reversal from the ECB's forecast of an economic rebound published in September. The bank has undoubtedly been startled by the latest PMI confidence data, which has a good record as a leading indicator and is now pointing to a brutal contraction of 2.7 percent year-on-year in early 2009.

In France, President Nicolas Sarkozy unveiled a E26 billion (L22 billion) stimulus package of tax cuts and state spending to fight unemployment. It includes E1 billion in loans for the French car industry, which is shutting a string of plants for up a month to clear an unprecedented glut of unsold vehicles. The state will build 100,000 new homes to keep construction alive.

Mr Sarkozy said the goal of restoring France's dilapidated public finances to good order could wait for better times. "Not doing anything now would have cost us much more. We're not going to sacrifice the present for the future. This crisis is an ordeal, a painful ordeal and a terrible ordeal, but we have to keep faith," he said.

Italy needs a stimulus package even more badly but is having to tread with care as markets fret over some E200 billion of Italian state debt that must be rolled over next year. The yield spread on 10-year bonds has risen to 123 basis points over German Bunds. Giulio Tremonti, Italy's finance minister, insisted yesterday that state bonds were at no risk. "Buy them. They are absolutely solid."

Mr Trichet signalled for the first time that the bank is considering some form of "quantitative easing" (QE), the term used to describe the emergency measures pioneered by Japan during its Lost Decade and now being adopted by the US Federal Reserve.

"We are supplying liquidity on an unlimited basis. We will continue to look very carefully at the situation of the market and if needed we will take new decisions," he said, when asked about QE measures.

Julian Callow, Europe economist at Barclays Capital, said the ECB had been caught off guard as the crisis gathered pace this year but is now beginning to catch up. "They are still being too hesitant given the gravity of what is happening. Even so, it seems they are now preparing for quantititave easing and undoubtedly have other tricks up their sleeve," he said.

The Maastricht Treaty prohibits the ECB from injecting stimulus by purchasing the government debt of the eurozone's fifteen states debt -- a method known as "monetizing the deficit" or, more crudely, as "printing money."

But it can achieve the same effect by mopping up sovereign debt, mortgage securities, or even company debt on the open market, as the Fed has already begun to do. At the moment the ECB accepts some of these assets as collateral in exchange for loans, but it has not yet hit the atomic button by buying them outright with its own freshly-minted fiat money.

* * *

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at http://www.gata.org/.