Thursday, the European Central Bank is widely expected to cut its benchmark interest rate to a new low and to announce further non-standard measures to pull the 16-nation economy out of its worst recession since World War II.
At its meeting in Frankfurt, the Governing Council, the policymaking body of the ECB, is expected to reduce the main refinancing rate by a quarter point to 1%. In the April session, the key interest rate was lowered by 25 basis points to 1.25%, defying expectations for a larger reduction of 50 basis points.
It is widely believed that the central bank would hold fire for a long period after today's rate cut. The ECB has lowered interest rates by a total of three full percentage points since early October 2008.
Governing Council member Ewald Nowotny recently said the central bank will keep the interest rate very low for as long a time as is required, and stands ready to use non-conventional measures of quantitative easing to assure European firms and consumers access to credit at appropriate conditions
The ECB was widely expected to announce non-conventional policy measures after its April rate-setting session. However, that did not happen and the central bank chief Jean-Claude Trichet said he would announce full details of any further non-standard measures after the next session. He also hinted at possible rate cuts, saying he is not ruling out a measured approach to take the key interest rate down further.
Making the task difficult for ECB, the Governing Council is divided on whether to cut the rate below 1% or adopt unconventional measures. Some ECB policymakers do not favor a benchmark interest rate below 1%. Germany's Axel Weber is of the view that if the interest rate falls below 1%, banks will have no incentive to lend to each other, paralyzing interbank lending. Italy's Lorenzo Bini Smaghi has also voiced a similar opinion.
Economists largely expect the central bank to have ruled out purchase of government bonds. The central bank is widely expected to extend the maturities on its loan to banks from the current limit of six months.
Central banks in the UK, the U. S. and Japan are buying bonds under their quantitative easing policies. The Swiss central bank has increased the number of long-term repo transactions. Further it is purchasing Swiss franc bonds issued by private sector borrowers and buying foreign currency on the open market.
Earlier in the week, the European Commission sharply lowered the GDP outlook for the euro area, which is now expected to contract 4% in 2009 and 0.1% next year. In its interim forecast in January, the commission said the euro area will contract 1.9% in 2009 and will grow 0.4% in 2010. The euro area unemployment rate is forecast to rise to 11.5% from 9.9% this year. The International Monetary Fund expects the Eurozone to contract 4.2% this year.
Policymakers expect headline annual inflation rate to decline further in the coming months and temporarily reaching negative levels around mid-year. Eurozone inflation remained at a record low of 0.6% in April, a flash estimate from Eurostat showed last week. The central bank targets inflation rate of below, but close to 2% over the medium term.
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