ECB Cuts Key Rate to 2.0% as Eurozone Recession Worsens

By , Money Morning •

By Jason Simpkins
Managing Editor
Money Morning

The European Central Bank (ECB) today (Thursday) cut its benchmark interest rate by half a percentage point to 2.0%, an acknowledgment that the Eurozone economy is rapidly deteriorating amid the global financial crisis.

"Looking further ahead, we continue to see global economic weakness," ECB President Jean-Claude Trichet said in a statement. "The euro zone should over time reap the full benefits...of policy measure announced over recent weeks."

The ECB, which prides itself on its hawkishness, has now shaved 2.25 percentage points off its key rate since October, as the financial crisis has broken down economies throughout the region.

The Eurozone - the 15 countries that use the euro - officially slipped into its first recession, last October after the region's gross domestic product (GDP) contracted by 0.2% in both the second and third quarters of 2008. Analysts estimate that GDP contracted further by 1% in the final quarter of the year.

The Organization for Economic Cooperation and Development (OECD) predicts that the Eurozone economy will contract 0.5% in 2009, in line with the International Monetary Fund's (IMF) most recent forecast.

Economic confidence in both the Eurozone and greater European Union (EU) hit a record low in December, as unemployment continued to soar.

The European Commission's economic sentiment indicator (ESI) fell 7.0 points to 63.5 in the EU and 7.8 points to 67.1 in the Eurozone. Both readings are the lowest since the indicator was launched in 1985.

The unemployment rate for both regions edged up in November, to 7.8% in the Eurozone and 7.2% in the large EU.

"Although the ECB initially would have liked to keep rates on hold, it has been overwhelmed by a series of dismal data," ING Bank NV economist Carsten Brzeski wrote in a note to clients. "The recession in the Eurozone seems to worsen by the day, while at the same time inflation is no longer a concern. Apparently, the ECB is willing to do everything necessary to get ahead of the curve."

Even with the cuts, however, the ECB still maintains the highest interest rates of all the Group Seven industrialized nations. And President Trichet will remain wary of taking rates too low, as an overabundance of cheap credit is widely blamed for the current financial meltdown.

Other central banks "have their own responsibility and decisions and I have already said that as far as we are concerned, we would be very, very keen to avoid to be put in a situation which for us would not be appropriate, namely a liquidity trap," Trichet said.

Inflation in the Eurozone cooled to 1.6% in December, its lowest level since October 2006, and below the central banks target of just under 2%. That has led many analysts to project the ECB will cut its benchmark rate again in March to a level of 1.5% - despite Trichet's hesitancy.

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