Saturday, January 3, 2009

ECB Papademos: Don't see recovery in 2009

Papademos Says ECB to ‘Act Appropriately’ in Slowdown (Update2)
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By Simon Kennedy

Jan. 3 (Bloomberg) -- European Central Bank Vice President Lucas Papademos said an economic recovery may not begin until next year and that policy makers have the scope to cut interest rates if inflation slows further.

“The economic outlook is unusually uncertain,” Papademos said in an interview with Germany’s WirtschaftsWoche magazine published today. “It is quite possible that the recovery will not start until the beginning of 2010.”

Having reduced their key interest rate by 175 basis points since early October to 2.5 percent, ECB policy makers enter the new year under pressure to cut more deeply amid Europe’s first recession in 15 years. Retail sales fell for a seventh month in December, manufacturing shrank at a record pace and lending to the private sector stagnated, reports showed this past week.

The economy may be even weaker in 2009 than the ECB’s prediction of last month for a contraction of about 0.5 percent, Papademos said. The Frankfurt-based central bank will “act appropriately” and has room to do so if the slowdown threatens price stability, which the ECB defines as inflation just below 2 percent in the medium term, he said.

“If, in our assessment, the risks to price stability change further in the coming months, monetary policy could be eased further and we will act appropriately,” Papademos said.

Inflation to Fall

The ECB’s current view is that the 16-nation economy will remain weak and contract for two to three more quarters with a “gradual recovery” in the second half of the year at the earliest, he said. While it is premature for the bank to revise its projections it “cannot rule out that economic activity in 2009 may turn out to be weaker than suggested,” he said.

Although deflation, a sustained period of falling prices, isn’t likely in the euro-area, inflation may “fall considerably” in the middle of 2009 before accelerating toward levels consistent with price stability by the end of the year, Papademos said.

The inflation rate fell to 1.8 percent last month, beneath the ECB’s target for the first time since July 2007, according to the median of 20 forecasts given by economists before a report scheduled for release in the coming week.

The fall in the price of oil from its peak of $147 a barrel last July as well as lower interest rates and taxes should support expansion, Papademos said.

Rate Expectations

Economists at Bank of America Corp. are among those anticipating the economy will be weaker than the ECB projects this year with a forecast for a 2.5 percent contraction. They expect the ECB to cut its benchmark to 1.5 percent this quarter even as officials such as President Jean-Claude Trichet signal a reluctance to pursue aggressive rate cuts.

The ECB’s governing council next meets Jan. 15 with investors indicating they expect a cut of at least 25 basis points, according to Eonia forward contracts.

Papademos said the ECB had “absolutely not” lagged behind counterparts such as the Federal Reserve in combating the economic fallout from the financial crisis. The Fed last month cut its main interest rate to as low as zero for the first time.

The economies and mandates of central banks differ and interest rates were higher elsewhere than in Europe when the turmoil began, Papademos said. “The fact that some central banks have lowered their key rates more quickly than us does not mean they are ahead of us,” he said.

‘More Time’

The difficulty facing the ECB is that the crisis means markets are not passing on interest rate cuts to the ECB as fast as they would traditionally, Papademos said. “In the current environment, it will take more time for interest rate cuts to affect economic activity and their impact may be weaker than is usually the case,” he said.

The ECB official urged banks to take advantage of government funding and better disclose the losses and risk they face. A proposal for a clearing house to guarantee loans between banks is a “concept worth exploring,” he said.

The ECB provided a transcript of Papademos interview to news media.

To contact the reporters on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net.

Last Updated: January 3, 2009 08:01 EST

A central banker will never come right out and say that there wont be a recovery in 2009.   But we have to interpret that Papademos is essentially saying that there wont be a recovery in 2009.   The ECB is signaling a change of their optimisitic forecast and will cut interest rates this quarter.  

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