ECB Head: Europe May Be Facing Recession

Reuters

The European Central Bank cut interest rates by a quarter point to 1.25 percent in a surprise move on Thursday and President Mario Draghi said the euro zone could subside into a "mild recession" in the latter part of 2011.

The Italian has walked into a maelstrom in his first week at the ECB's helm, with euro zone leaders contemplating a future without Greece and economic policy paralysis in his home country threatening to pitch Rome into the storm.

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offered no commitment to scale up the central bank's bond-buying programme to support the likes of Italy and Spain, instead describing the purchase plan as "limited."

"What we are observing now is ... slow growth heading towards a mild recession by year-end," Draghi told a news conference at which he used some of his predecessor Jean-Claude Trichet's lines, while mixing in a dash of humour in an assured debut.

"A significant downward revision to forecasts and projections for average real GDP growth in 2012 (are) very likely," he added.

The rate cut, which Draghi said was a unanimous decision by the ECB's 23-member Governing Council, gave a boost to stock markets. The FTSEurofirst 300 index of top European shares was up 1.8 percent at 1600 GMT.

The decision came despite inflation in the 17-country euro zone staying at 3.0 percent for a second month running in October, well above the ECB's target of just below 2 percent.

Draghi said the ECB expected inflation to subside below 2 percent next year, with wage and cost pressures abating as economic demand evaporated.

"We expect another rate cut to follow in December and there is a clear risk of the main policy rate breaking below 1 percent next year," JP Morgan economist David Mackie said.

While the ECB shocked markets with the rate cut, Draghi took a much more conservative stance on the bank's bond-buy programme, which has come into increasing focus as Greece's uncertain future in the euro zone deepens the bloc's crisis.

European leaders said earlier they were prepared for Greece to leave the euro zone to preserve their 12-year-old single currency if Athens does not decide quickly to implement a bailout programme, putting the likes of Italy and Spain, and even France, firmly in the markets' sights.

Europe's ultimatum to Greece, after Prime Minister George Papandreou's attempt to call a referendum on a bailout plan, has raised pressure on the ECB, which many analysts see as the only institution with the firepower to bring calm.

When asked about a possible Greek exit from the common currency bloc, Draghi said such an option was not in the treaty.

NO SHIFT ON BOND BUYING

Draghi gave no hint that the ECB's bond-buy programme, a controversial tool that has led to the resignation of two German policymakers, would be accelerated despite the chaos in Greece threatening to engulf the much larger economies of Italy and Spain.

"Our securities market programme has three characteristics: it is temporary; it is limited; it is justified in restoring the functioning of monetary transmission channels," he said.

Draghi succeeded France's Trichet as ECB chief on Tuesday -- a day that saw the ECB buy Spanish and Italian bonds but barely manage to cap a rise in yields on the debt of the euro zone's third largest economy.

He said the ECB had not been focusing on Italian bond yields and stressed that the bank would "not be forced by anybody" to buy bonds. He said it was pointless to think sovereign bond yields could be brought down for a protracted period by outside intervention.

"Here Draghi took a very conventional stance," Mackie said in a research note, noting that he also dismissed the idea of the ECB being a lender of last resort.

Trichet had signalled previously that the ECB was keen to withdraw from the bond-buying policy once the euro zone's EFSF rescue fund gained new powers to intervene on bond markets.

Draghi must balance an eagerness to curry favour with the German contingent at the ECB against growing financial market pressure to intervene on a bigger scale to lower the borrowing costs of Italy and Spain.

Many in Germany, where the legacy of hyperinflation in the 1920s has left people with a strong aversion to price rises, are concerned about an Italian taking over the ECB presidency.

Draghi sought to reassure Germans, saying he had "great admiration for the tradition of the Bundesbank," the German national central bank on which the ECB is modelled.

"As for the future, let me do my work and we will have periodic checks whether I am in sync with that tradition or I deviate from that," he said.