FRANKFURT, March 1 – The European Central Bank is set to cut its interest rates to all-time lows Thursday after eurozone economic activity hit its own record low in February and the bloc shed a quarter of a million jobs.
The ECB also faces tough choices on how to help protect vulnerable eastern European economies from being swept up in the global financial crisis.
"There is every reason to expect the ECB to cut interest rates by 50 basis points to 1.5 percent this month," Capital Economics economist Jennifer McKeown said.
Spanish central bank governor Miguel Ordonez, a member of the ECB governing council, said last week: "You know that we never pre-commit, but we generally do not take the markets by surprise."
The ECB has slashed its benchmark rate from 4.25 percent to 2.0 percent since October, but markets look for record levels now as the eurozone economy wallows in its first recession.
For many eurozone members, the slump is the heaviest since the 1930s Great Depression and the situation has grown worse with the realisation that formerly dynamic economies in eastern Europe are much weaker than previously thought.
Figures released Friday showed that battered eurozone economies lost 256,000 jobs in January, pushing the unemployment rate up to 8.2 percent, the highest level since September 2006.
The European Commission\’s economic sentiment index has hit its lowest level since the survey began in January 1985, and business activity is also at a record low.
Eurozone industrial orders, a sign of what is to come, have now fallen for five months running.
European exports collapsed as economies around the world suffer from the economic downturn, business investment is on hold and consumers have pulled back amid gloomy news from the employment front.
"The miserable state of the economy at the end of the year will continue in the first quarter" of 2009, UniCredit economists wrote in a research note.
Eurozone output contracted by a record 1.5 percent in the last quarter of 2008, and "will contract strongly again at the beginning of the year," they added.
McKeown at Capital Economics noted that the 16-nation bloc has lost almost a million jobs since November, and saw unemployment "rising beyond 10 percent this year and further in 2010."
The ECB rate cuts and government stimulus packages are expected to help boost activity later this year but consumers are likely to rein in spending until they are convinced that better times are on the way.
Meanwhile, inflation has also plunged from a peak in mid-2008 owing to lower oil prices and the economic downturn.
In January, inflation fell by the sharpest rate on record, to 1.1 percent, well below the ECB target of just under 2.0 percent, and analysts expect it to dip into negative territory in the middle of the year.
On Thursday, the ECB will also release staff forecasts for inflation and growth, with both expected to be revised markedly lower from their level in December.
Once again therefore, the question is how low the ECB\’s interest rate might fall, and if it approaches zero, whether the bank would use unconventional measures known as quantitative easing to underpin activity.
Several analysts feel a zero interest rate is possible, though Axel Weber, head of the German central bank and an influential ECB governor, said last week: "For me, the floor will be a refinancing rate of 1.0 percent."
McKeown said "the more interesting issue is the scope for unconventional policy measures to support the economy."
The US Federal Reserve and the Bank of England have bought assets such as commercial paper issued by businesses, but that market is not well developed throughout the eurozone.
The ECB cannot buy government securities directly, and buying on secondary markets "would involve tricky negotiations over which government\’s debt it should buy," McKeown said.
Finally, the ECB has been urged by countries such as Poland to ease criteria for adopting the euro as a way to shield quivering eastern European currencies.
UniCredit chief economist Marco Annunziata said "this would cause additional headaches for the ECB," but did not dismiss such a development, noting that "the crisis is forcing policymakers to deploy all available weapons."