A structure showing the Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt.ALEX DOMANSKI/Reuters
After the European Central Bank left interest rates unchanged in December, president Mario Draghi provided a gloomy assessment of the euro-zone economy, acknowledged that some members of the bank's governing council had pushed for a rate cut and opened the door to such a move if conditions do not improve.
Yet despite more troubling signs of weakness and clear evidence that the economy shrank again in the fourth quarter, marking nine consecutive months of decline, the ECB is expected to stand pat at its policy meeting Thursday. The Bank of England's policy-setting committee, which meets at the same time, is also likely to keep rates where they are, although the British economic picture is similarly clouded.
"I don't think either of them is going anywhere," said Howard Archer, chief European economist with IHS Global Insight in London. The Bank of England "is very much in a wait-and-see mode at the moment" and the ECB will probably wait another month or two before reducing its key rate from 0.75 per cent, he said.
"I'm not sure it would make a huge difference, but I personally think there's a compelling case for them to cut," Mr. Archer said, noting that ECB policy remains tighter than that of the Bank of the England (with a key rate of 0.5 per cent) or the U.S. Federal Reserve (zero to 0.25 per cent), despite the euro zone's bleak economic prospects. The Bank of Canada rate is 1 per cent. "I still think the ECB will cut in the first quarter. But they may well hold fire this month."
Still, Mr. Archer and other bank watchers said they would not be surprised if the ECB chose to cut rates sooner rather than later.
The ECB "has to do something to address the risk to price stability caused by a crunch of money and credit," said Carl Weinberg, chief economist with High Frequency Economics, who thinks the bank will reduce its key rate by a quarter of a percentage point this week. Because the ECB has no mandate to pursue quantitative easing, "we think the council will – grudgingly – vote to ease monetary conditions with lower interest rates."
But the more hawkish council members have argued that another interest rate cut would do nothing for the economy, that there is no shortage of cheap capital and banks can already borrow at much lower costs than the official rate.
"There's more than sufficient liquidity throughout Europe," agreed Benjamin Reitzes, senior economist with BMO Nesbitt Burns. But he argues that the ECB should still be cutting rates. "At least it would show that they're aware that the risks are to the downside and it would help banks modestly, because they borrow at that rate through the [ECB's] long-term refinancing operations."
As for Britain's monetary policy minders, "it doesn't look like they have any real appetite to do anything more just yet," Mr. Reitzes said. "Given the economic backdrop there, the reality is that they should probably be easing further. There have been a few positive signs, but their close ties with Europe mean that they're probably going to have a tough time for a while yet. And they have their own austerity measures to work through still."
The latest grim news for the British economy comes from the crucial services sector, where a key purchasing managers' survey indicates that activity contracted in December – the first such decline in two years. The unexpected weakness in a sector that accounts for about 75 per cent of British output heightens the risk that the economy is headed toward another recession, the third in just five years. Analysts had expected a slight improvement.
"This reinforces our belief that the Bank of England is likely to eventually give the economy a further helping hand with a final £50-billion of QE during the first half of 2013," Mr. Archer said.