Falling sales, weak lending put rate cut pressure on ECB

Updated: Dec 31 2008, 07:06am hrs
The European Central Bank will begin the new year under pressure to keep cutting interest rates after retail sales fell for a seventh successive month and loans to households and companies grew at the slowest pace in four years.

Retailers reported sales, jobs and profit margins all contracted this month as the deepening recession curbed consumer confidence and spending, the Bloomberg purchasing managers index showed. Tighter credit standards at banks meant private sector lending slowed for an 11th month in November, rising 7.1% after a 7.8% increase in October, the ECB said.

The deteriorations mean the 15-nation euro area will mark a decade of the single currency on Jan 1 facing a deepening recession. That leaves investors betting the ECB will reduce interest rates as early as next month even as its officials signal a reluctance to do so after cutting their benchmark by 175 basis points to 2.5% since early October.

The ECB will have to go further, said Gilles Moec, an economist at Bank of America Corp. in London and a former Bank of France official. The euro region faces a severe and protracted recession. The measure of retail sales in the euro area rose to 41.4 in December from 40.6 in November, remaining below the 50 limit that indicates shrinkage. The Bloomberg index, based on a poll of around 1,000 executives by Markit Economics, also showed that retailers sliced jobs for a ninth month and by the most in four years. Profit margins fell at a record pace.

Consumer spending going forward will remain as weak as it has been in the last few months, said Nick Kounis, chief European economist at Fortis in Amsterdam.

M3 money supply, which the ECB uses as a gauge of future inflation, slowed to 7.8% from a year earlier as demand for the most liquid assets retreated. Economists had expected the rate to decelerate to 8.5% from 8.7% in October, according to the median of 28 forecasts in a Bloomberg survey. The recent steady downward trend suggests that tighter credit conditions are impacting more, said Howard Archer, chief European economist at Global Insight Inc. in London. Todays reports were the latest to suggest the euro-areas recession deepened this quarter. Consumer confidence fell to a 15-year low in November, while manufacturing and services industries contracted in December at the fastest pace in at least a decade.

Inflation is also fading throughout the region. The rate of annual consumer price growth slowed in five German states this month. The price of crude oil has dropped more than 70% from a July peak of $147 a barrel, alleviating price pressures. Investors are predicting slumping growth and fading inflation will force the ECB to lower rates by 50 basis points when its governing council convenes Jan 15, Eonia forward contracts show. BlackRock Inc., Schroder Investment Management and Standard Life Investments Ltd., which together oversee $1.6 trillion, are buying German debt securities in a sign they expect deeper cuts from the ECB next year.

Thats despite recent comments from ECB officials such as President Jean-Claude Trichet that suggest the bank may pause in January after its unprecedented 75-basis-point rate cut on Dec 8. Trichet said Dec 15 that policy makers have a feeling there is a limit to the decrease in rates amid frozen credit markets and that they would like to concentrate at this stage on getting what we already decided to be really operational.