BORROWING COSTS:EURO ZONE interest rates could soon be cut for the first time in five years, the European Central Bank (ECB) signalled yesterday, after acknowledging that global financial turmoil had changed substantially the economic outlook for the 15-country region.
Jean-Claude Trichet, ECB president, opened the door for a possible cut in official borrowing costs from 4.25 per cent in November - or earlier if the financial market crisis escalates - by saying that although euro zone inflation risks had not disappeared, they had fallen.
His comments amounted to a significant change of tone at the Frankfurt-based institution, which raised interest rates only in July to head off inflation dangers.
The ECB has held off cutting rates because of its concern that the jump in inflation will become entrenched through a wage-price spiral as workers seek compensation for the higher cost of living.
While inflation in Europe slowed to 3.6 per cent in September after crude oil prices retreated from a July record of $147.27 a barrel, it is still above the ECB's 2 per cent limit.
Mr Trichet hinted at European policymakers' alarm at developments in the US, saying that allowing Lehman Brothers to collapse had had "enormous . . . very unfortunate consequences".
Mr Trichet said ECB policy-makers recognised "the extraordinary high level of uncertainty stemming from latest developments" on turbulent financial markets and the credit crunch. "Economic activity in the euro area is weakening with contracting domestic demand and tighter financing conditions," he said.
"The ECB is adopting a substantially softer tone, which opens the door for a future interest rate cut," said Howard Archer, chief European economist at Global Insight.
The ECB governing council had discussed cutting interest rates yesterday before deciding "unanimously" to hold them steady at 4.25 per cent, he revealed.
The Wall Street Journalreported that US Federal Reserve officials are weighing further interest rate cuts, even if Congress approves a $700 billion financial industry bailout, because of a worsening economic outlook.
A rate cut is still far from certain, partly because of inflation worries, the Wall Street Journalsaid in an unsourced report on its website. In Britain, Marks Spencer, the UK's largest clothing retailer, urged the Bank of England to cut interest rates, saying it would "give confidence to consumers". The Bank of England, whose key rate is currently at 5 per cent, next decides on borrowing costs on October 9th.
The newly dovish tone at the ECB contributed to a sharp slide in the euro, which fell to $1.37 - a one-year low against the dollar - and Y145.50. It also came on a day of continued market nerves, caused not least by new figures showing the continued contraction of the commercial paper market.
The world's biggest financial institutions have recorded almost $600 billion in write-downs and losses tied to the US mortgage market since the start of 2007, driving Lehman Brothers into bankruptcy and forcing governments to rescue banks in the US, UK and Europe.
- (Financial Times service, Bloomberg and Reuters)
