Trichet Reverses Stance on Rates, Sees Growth Risks (Update1)

By Simone Meier and Gabi Thesing


Feb. 7 (Bloomberg) -- European Central Bank President Jean- Claude Trichet reversed course and signaled he's open to cutting interest rates for the first time in five years as economic growth falters.

Trichet dropped a threat to raise rates after economic reports in the past week showed Europe being infected by the slowdown in the U.S. economy. The region's service industries grew at the slowest pace in more than four years in January, and consumer and executive confidence fell to a two-year low.

``Uncertainty about the prospects for economic growth is unusually high,'' Trichet said in Frankfurt today after the ECB kept its benchmark interest rate at 4 percent. The Bank of England reduced its key rate by a quarter point to 5.25 percent today.

The comments are a ``capitulation'' after Trichet said last month that growth in emerging markets such as China and India would cushion the effect of a U.S. slowdown, said Jacques Cailloux, chief European economist at Royal Bank of Scotland Plc.

The ECB president said the bank's 21-member council no longer considered increasing rates, as it did last month, and that the degree to which emerging markets can offset the U.S. was ``an open question.'' The euro fell and bonds rose following his remarks.

The ECB has kept borrowing costs at a six-year high since June to contain inflation. By contrast, the U.S. Federal Reserve last month lowered its key rate by 1.25 percentage points to 3 percent, the fastest pace of cuts since 1990.

Investors Predict Cuts

The ECB's shift paves ``the way for a possible rate cut in the future, should the economic situation continue to deteriorate,'' said Sandra Petcov, an economist at Lehman Brothers International in London.

BNP Paribas SA and Royal Bank of Scotland brought forward their forecast for a rate cut to April and Rabobank Groep NV now predicts the bank will lower lending rates twice this year instead of keeping them unchanged.

Investors are raising bets the ECB will have to pare its benchmark at least twice this year, according to futures trading. The yield on interest-rate contracts maturing in December fell as much as 18 basis points to 3.34 percent today, 66 basis points below the ECB's benchmark rate. It was as high as 4.36 percent on Dec. 27, and has averaged 31 basis points more than the central bank's key rate for the past five years.

The euro weakened to $1.4496 from $1.4632 yesterday and the yield on 10-year German bunds fell as much as 5 basis points to 3.85 percent.

Slower Growth

The International Monetary Fund on Jan. 29 lowered its 2008 euro-region growth estimate by half a point to 1.6 percent, saying that ``no one is going to be exempt from some slowdown.'' The Washington-based fund also trimmed its growth estimates for the U.S. and Japan, the world's two largest economies.

The ECB on Dec. 6 projected economic growth of about 2 percent this year after 2.6 percent in 2007. Trichet said today the latest data confirmed the bank's assessment that ``risks surrounding the economic outlook lie on the downside.''

Stock markets have dropped this year on concern the U.S. economy is sliding into a recession after the collapse of subprime mortgages, aimed at borrowers with poor credit histories. The slump pushed up credit costs worldwide as banks became reluctant to lend to each other. Germany's benchmark DAX Index has lost 16 percent and the Dow Jones Stoxx 600 Index 12 percent.

UBS AG, Europe's largest bank by assets, last month reported $14 billion of subprime-related charges, bringing the total for the world's largest financial institutions to more than $145 billion. Josef Ackermann, chief executive officer of Deutsche Bank AG, said today 2008 will ``remain challenging.''

BOE Cut

The Bank of England's cut today was the second in three months and took its benchmark to 5.25 percent, still the highest among the Group of Seven industrialized nations. That was still more cautious than the Fed, which has pared rates five times since September.

U.K. policy makers said in a statement today they need to balance the risks to economic growth against the threat that inflation may become entrenched above the 2 percent target.

Trichet said today he remained concerned about a potential wage-price spiral as workers demand compensation for higher prices. Inflation in the 15 euro countries accelerated to 3.2 percent in January. The ECB predicted in December that price gains will average about 2.5 percent this year after 2.1 percent in 2007. It would be the ninth year the ECB fails to achieve its goal of keeping inflation just below 2 percent.

``If I was Jean-Claude Trichet, I wouldn't cut interest rates,'' Deutsche Bank's Ackermann said in an interview. ``The ECB should keep its course and not follow the Fed.''

``The ECB sounds more worried by downside risks to growth than in previous months,'' said Dario Perkins, an economist at ABN Amro Holding NV in London. ``This suggests the tightening bias has gone. But don't assume this means interest-rate cuts are coming soon. The ECB is still constrained by inflation.''