ECB expected to cut, may take more to sustain markets

Tue Jul 3, 2012 5:50am EDT
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By Paul Carrel

FRANKFURT (Reuters) - The European Central Bank is expected to cut interest rates to a record low on Thursday but may need to do more to satisfy financial markets already starting to wonder about the solidity of last week's summit measures to tackle the euro zone crisis.

Steady inflation and a dire batch of economic performance indicators, including signs of weakness in euro zone powerhouse Germany, give the ECB cover to back up the EU summit deal with a quarter-point cut in its benchmark rate to 0.75 percent.

The ECB has never cut its main refinancing rate below 1 percent but policymakers say there is nothing to stop them doing so and they may want to bolster euro zone leaders, even if they never admit to such 'quid pro quo' deals.

At the summit, ECB President Mario Draghi strolled into the middle of the media zone to declare his satisfaction with the agreement to speed up cross-border banking supervision and to allow the euro zone rescue fund to recapitalize banks directly thereafter.

"I think Draghi saying that he is happy with the summit results is a strong sign that the ECB is ready to do something," said Christian Schulz at Berenberg Bank, forecasting a quarter-point cut.

But Schulz, a former ECB economist, added: "We think if it's just a rate cut, that would be a disappointment for markets because a rate cut would not do very much at all for the peripheral economies ... that's why something else is needed."

Markets have rallied since the EU meeting, which also empowered the ECB to lead the supervision of European banks and opened the way for the rescue fund to intervene on debt markets to support troubled members, though Finland and the Netherlands have questioned this bond-buying provision.

Even with political backing, there are questions over the rescue fund's capacity to lower borrowing costs. It has a maximum 500 billion euros capacity with 100 billion already earmarked for Spanish banks, a sum which could quickly dwindle.   Continued...