MercoPress. South Atlantic News Agency

ECB lowers rate to 2.5%, but cautions about further cuts

European Central Bank President Jean Claude Trichet said on Thursday cutting interest rates too low or too fast could leave policy makers with few options to respond to a deepening recession.

"We have to beware of being trapped at nominal levels that would be much too low," Trichet said at a press conference in Brussels. The ECB earlier lowered its benchmark by three quarters of a percentage point to 2.5%, the biggest cut in its ten-year history. Trichet said the decision was reached by "consensus" and declined to divulge if there were calls for smaller or bigger cuts. He emphasized that the ECB has reduced rates by 1.75 percentage points since October after the financial-market crisis intensified. While "global and euro-area demand are likely to be dampened for a protracted period of time," lower commodity prices may support a gradual recovery from the second half of next year, Trichet said. As well as cutting rates, ECB has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said it may be possible for the ECB to purchase assets and securities outright. "If new decisions are needed we will take new decisions, but I can't say anything else at this stage" he said. "We continue to look very carefully at the situation of the market and the situation of the economy." The latest ECB forecasts show the euro-region economy will shrink about 0.5% next year, which would be its first full-year contraction since 1993. Inflation will average about 1.4% in 2009 and 1.8% in 2010, the new projections show, meeting the ECB price-stability goal of keeping the rate just below 2%. The 15-nation economy is already in recession and Trichet said the slump probably worsened in the fourth quarter. Turmoil on financial markets could further weaken the Euro zone economy: "the level of uncertainty remains exceptionally high". Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing the inflation rate fell the most in almost 20 years last month, to 2.1% from 3.2% in October. Analysts believe Trichet wants to avoid the same problem facing Federal Reserve Chairman Ben Bernanke who is being forced to draw up unorthodox tools after cutting its benchmark rate to 1%. The ECB has been more measured than other central banks in its policy response to the global recession and some of the ECB 21 policy makers have advocated a steady- hand approach to tackling the recession. Luxembourg's Yves Mersch was quoted in his country's press saying that ECB is "entering calmer waters" with future rate changes more likely to be in the order of 25 basis points. Executive Board member Lorenzo Bini Smaghi said at the end of October that "the present crisis is partially due to interest rates that remained at low levels for too long".