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DateLine Thursday, 2 October 2008

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ECB under pressure to cut lending rate

The European Central Bank will likely keep its main lending rate steady on Thursday amid unprecedented market turbulence but pressure is building for a cut in the coming months, analysts say.

ECB president Jean-Claude Trichet has repeatedly cited inflation risks for the ECB's insistence on holding interest rates steady or even increasing them, as in July, instead of going for a reduction to spur slumping economic growth.

Most analysts fully expect the ECB to leave rates on hold at 4.25 percent when its governing council meets in Frankfurt despite a slowdown in inflation and the worst financial crisis since the Great Depression of the 1930s.

However, at some point, they believe an interest rate must come, perhaps as part of a coordinated move to encourage the commercial banks to begin lending again so as to avoid a deep and long lasting recession.

"In the current environment, it's becoming increasing difficult for the ECB to maintain the view that inflation remains the predominant concern," UniCredit Markets economist Marco Valli said. Inflation in the 15-nation eurozone eased for the second month running in September to 3.6 percent, from 3.8 percent in August and a record 4.0 percent in July.

That is still way above the ECB's target of just below 2.0 percent but it reinforces the view that inflation might finally have peaked.

Additionally, the latest survey of eurozone business confidence showed it dropped in September to its lowest level since just after the 2001 terror attacks on the United States.

Meanwhile, the failure Monday by US lawmakers to approve a 700-billion-dollar (485-billion-euro) plan to bail out the US banking system rattled European leaders struggling to protect their own banks.

"In such an environment, the pressure on the ECB to cut rates is mounting," Bank of America economist Gilles Moec said, adding that inflation risk will remain a major concern of the bank.

For UBS economist Sunil Kapadia, "the question on investor's lips at the moment is: Will the ECB cut rates in 2008?"

Most analysts feel an immediate decrease is out of the question because the ECB raised its rate in July and such a quick about-face could spark panic in tense financial markets.



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