ECB pulls quick trigger on half-point rate cut

The European Central Bank cut its key interest rate by half-a-percentage point on Thursday even though the bank's president says Europe has not digested past rate reductions.

The ECB, which controls monetary policy in 16 European states, chopped its refinancing rate by 50 basis points to two per cent in a bid to boost borrowing despite the lack of interest by chartered banks in lending cash to companies or individuals.

"Credit conditions remain uncomfortably tight across the Eurozone: there are signs that this is increasingly weighing down on businesses and consumers," said Global Insight Inc., a Massachusetts-based economic forecaster, before the ECB's announcement.

With Thursday's move, the continental central bank has cut its refinancing interest rate four times since September, when the benchmark figure stood at 4.25 per cent.

The move was designed to reduce what borrowers pay to get cash and hopefully generate more economic activity.

In recent statements, however, bank president Jean-Claude Trichet believed that the positive effects from past rates cuts have not been transmitted throughout the European economy as yet.

"In particular, ECB president Jean-Claude Trichet highlighted that the full effect of the recent 175-basis-point reduction in rates has far from fully filtered through to affect economic activity," Global Insights said in the same note.

OECD predicts domestic demand will rebound

The ECB, which is considered to be hawkish on inflation, plans to outline the reasons for its decision in an afternoon press conference.

But, as interest rates in many countries creep towards zero, analysts are questioning whether the borrowing reductions are having any effect on the economy.

The Eurozone area, which now includes new member Slovakia, slipped into a reversionary mode earlier than either Canada or the United States. The continental countries saw their gross domestic product shrink by 0.2 per cent in both the second and third quarters of 2008.

With the last three months of the year likely to produce an even bigger contraction, Europe will have been in a technical recession before 2009 even began.

The rate reductions, however, began in earnest in October.

The common wisdom sets six months as the point at which rate reductions begin to generate economic activity.

The ECB might be nervous that too many rate cuts now could lead to accelerating inflation by the end of the year, analysts said.

The Organization for Economic Co-operation and Development forecasts that total domestic demand will fall by 0.5 per cent in 2009, but rebound somewhat to a positive 1.1 per cent.

It is the rebound that might have the ECB concerned, economy watchers said.