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ECB to cut rates to record low next week

LONDON - The European Central Bank will cut interest rates to a new record low next week and it may have to take more emergency measures soon to placate financial markets, a Reuters poll showed on Wednesday.

Taken ahead of Thursday’s summit of European leaders, the survey also suggested they will emerge with the first steps towards a euro zone banking union, and perhaps a fiscal union, even if only in vague terms.

But few expect the summit to yield immediate help that could push the euro zone economy out of its current malaise, which most economists say will force the ECB to cut interest rates to 0.75 percent from 1.0 percent next week.

Even two weeks ago, most economists thought the ECB would hold rates for the foreseeable future. Yet the latest data suggest the euro economy is in a steepening downturn, bringing an abrupt change in the consensus.

Bank of England Governor Mervyn King encapsulated the growing sense of alarm in comments on Tuesday that were resolutely downbeat not just about the euro zone, but the global economy overall.

Forty-eight out of 71 analysts now expect the ECB will trim interest rates next Thursday, with most of them predicting a cut to 0.75 percent, where they will stay until 2014 at least.

“A modest cut would be justified even without the current intensification of the financial market turmoil,” said Christian Schulz, senior economist at Berenberg Bank.

“Especially if the EU summit results spark a market panic but are considered as going into the right direction by the ECB, the ECB could cut rates by more than just 25 basis points.”

Twenty-one out of 55 economists thought European leaders will emerge with an outline for both a banking and fiscal union, while 17 thought only a plan for a banking union would result.

With marked discord among the top power brokers, notably German opposition to the creation of a shared euro zone government bond, 10 respondents said the meeting would yield nothing.

“There appears to be more scope for progress on banking union, with the touted moves towards fiscal union likely to come up against tougher opposition,” said Victoria Clarke, economist at Investec.

Making an impression

There was a strong consensus among economists the ECB will do more to calm financial markets after the EU summit.

The ECB has pumped out more than 1 trillion euros of cheap three-year loans since December to keep struggling banks flush with liquidity.

Nineteen out of 43 economists who thought the ECB will take further action said it will flood banks with more cheap long-term refinancing operations (LTROs) in future.

“We think a 1-year LTRO would be a good compromise between the need to address the funding stress that some peripheral banks have experienced recently, and the Bundesbank opposition to another 3-year LTRO,” said Thomas Costerg, economist at Standard Chartered.

He added that a sharp drop in market confidence could yet force the ECB into another 3-year loan operation.

Fifteen economists also said the central bank could resume its programme of buying government bonds for states whose borrowing costs are surging, like Spain and Italy.

Another 15 said the ECB will further ease the standard of collateral it requires from banks in return for its cheap loans.

The US Federal Reserve last week extended its Operation Twist programme, which is designed to push down borrowing costs by replacing its short-term securities holdings with longer-term ones.