Predictions of ECB rate cut grow as growth fades - even in Germany

Wednesday 24 April 2013 14.33
Germany's Ifo index falls to 104.4 in April from 106.7 in March
Germany's Ifo index falls to 104.4 in April from 106.7 in March

A key measure of German business optimism fell in April, suggesting Europe's biggest economy might not be rebounding as expected and likely putting more pressure on the European Central Bank to cut interest rates.

The Ifo institute said that its index fell to 104.4 points from 106.7 in March. Market analysts had expected a more modest decline to 106.2.

Germany has been one of the more resilient economies in the euro zone in recent years.

A slowdown in its economy, which accounts for 28% of the euro zone's total output, would make it harder for the region to climb out of recession.

The German economy shrank 0.6% in the last three months of 2012.

Most economists expected it to grow this year, but those predictions have been shaken this week by a weak survey of activity in the manufacturing sector.

The chief of the Ifo's survey, Kai Carstensen, said the index remained at a high level but showed increased doubts about the future. "The German economy is taking a breather."

That could make officials at the ECB more inclined to cut interest rates to support growth. Analysts said that resistance to a rate cut is crumbling.

The ECB's 23-member governing council has discussed cutting rates in recent months, but held off because officials think another cut from the record low of 0.75% would do little good.

Rates are already low but the cheap financing is not reaching many companies because troubled banks in some parts of the euro zone are reluctant to lend.

Analysts say a rate cut might do little to spur lending but could lower the euro's exchange rate, which would help exporters. Lower rates make interest-bearing investments in euros less attractive and reduce investor demand for the currency.

Analysts at Swiss bank UBS have changed their forecasts and now predict an ECB rate cut on May 2. They had previously expected rates to remain unchanged through the end of next year. Royal Bank of Scotland analysts Richard Barwell and Xinying Chen also shifted their prediction to a cut to the May meeting.

They noted that ECB President Mario Draghi said in April that the bank remained "ready to act" in case the economic indicators worsened.

In a sign that support for a rate cut may be growing, the head of the German central bank, which has typically been more reluctant to back rate cuts, said last week that a cut could be warranted if economic indicators worsen. Since his comments, they have.

The ECB's key interest rate is what it charges to lend to banks. As a result, it influences a host of other rates that determine how much it costs businesses and consumers to borrow.

Low rates in theory encourage borrowing to spend and invest, stimulating the economy. But rates are already low, and top ECB members have argued that the cheap financing is simply not reaching many companies. That is because troubled banks in some parts of the euro zone are reluctant to lend.

The ECB has also been looking at unspecified new way to help the economy that go beyond interest rates. Analysts say the ECB might take steps to try to increase bank's willingness to make loans to small and medium size businesses, which provide most of the euro zone's jobs.

Ideas that have been floated include loan guarantees from another European Union agency, or permitting banks to bundle loans to small businesses as securities and use them as collateral to get cash loans from the ECB.