Global Recession? ECB Drops Rates amid Gloomy IMF Forecasts

The International Monetary Fund said on Thursday that 2009 may see a global recession as economic data continues to be negative. The ECB and the Bank of England both announced significant interest rate cuts as markets continued to plunge.


With the raft of bad economic news continuing in the United States and Europe, the Bank of England and the European Central Bank (ECB) on Thursday made deep cuts to their interest rates. In the morning, the Bank of England surprised analysts by slashing the rate by a hefty 1.5 percentage points, the deepest cut ever made by the bank since it gained independence to set rates 11 years ago. The ECB followed with a more moderate drop of 0.5 percent.

Stock market indexes fell around the world on Thursday.
REUTERS

Stock market indexes fell around the world on Thursday.

The ECB cut had been widely anticipated after bank president, Jean-Claude Trichet, indicated on Oct. 8 -- when the ECB joined a coordinated rate cut with numerous central banks around the world -- that further rate cuts would likely be coming. Because investors had already factored in the rate cut, European stocks continued to fall on Thursday, following the lead of markets in Asia. Germany's leading index, the DAX, was trading down 4.4 percent on the day in the mid-afternoon.

The rate cuts come as the International Monetary Fund released its economic outlook update on Thursday forecasting 2009 global economic growth at just 2.2 percent, down 0.75 percent from its October forecast. The IMF defines a global recession as growth below 3 percent annually. Economies in industrialized countries, taken together, will shrink by 0.3 percent in 2009, the IMF predicts. Improvement won't be seen until the end of next year, the report says.

The ECB rate now stands at 3.25 percent, its lowest point in two years. Still, analysts expect more cuts are on their way. "It is clear that interest rates have to drop still further and that they will indeed be reduced," Norbert Braems, an analyst with the Frankfurt-based investment bank Sal. Oppenheim, told Reuters on Thursday. "By the end of the first quarter of 2009, we will see a prime interest rate of 2.5 percent or even lower."

A number of analysts in Britain referred to the Bank of England rate cut as "astonishing" and "spectacular." Still, even there, observers expect the rate to continue dropping. "There is still more to do," Jonathan Loynes of Capital Economics told Reuters. "At 3 percent, UK interest rates are still well above US ones when economic conditions suggest they should be as low if not lower…. Our view remains that UK rates will fall to 1 percent or below."

The deep cut was welcomed, but also reinforces the view that the British economy is headed for a deep recession. Trichet indicated that the ECB had considered making a larger cut itself, but ultimately decided that a half-point drop was appropriate. The economy in the 15-country bloc that uses the euro shrank by 0.2 percent in the second quarter of this year and most expect that economic data to be released on Nov. 15 will reveal further negative growth. The Swiss central bank also cut its interest rate by 1.5 percent on Thursday.

In its Thursday report, the IMF predicted that the German economy will shrink by 0.8 percent in 2009. The forecast jibes with a gloomy report released on Thursday by Germany's Economy Ministry indicating that orders coming in to German companies dropped by 8 percent in September as compared with orders in August. The size of the plunge was a surprise as August orders had actually risen by 3.5 percent relative to July.

Also on Thursday, it became clear that Germany's state development bank KfW stands to lose millions as a result of investments made in Iceland. The bank had invested €288 million with various Icelandic banks and stands to lose at least a chunk of that total. KfW said it would have to write off €150 million loaned to Glitnir bank, though some of that total may ultimately be paid back. A further €138 million was invested with the wobbling banks Landsbanki and Kaupthing.

cgh -- with wire reports

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