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European central banks slash interest rates

BRUSSELS – European central banks took unprecedented action Thursday to ward off a looming recession, slashing their benchmark lending rates to boost business investment and household spending.

The ECB cut the cost of borrowing in the 15-nation eurozone by a record 0.75 percentage points to 2.50 percent as the eurozone faced its first recession while the Bank of England returned Britain to World War II levels with a full point reduction to 2.0 percent.

For the ECB, it was also an unprecedented third rate cut in two months, following a coordinated cut with other central banks on October 8 and another reduction in early November.

"The ECB’s 75 basis point interest rate cut comes as a pleasant surprise after recent hints from governing council members that a 50 basis point cut was more likely," said Jennifer McKeown at consultants Capital Economics.

In Stockholm, the Swedish central bank set the tone early in the day by nearly halving its key rate by 1.75 percentage points to 2.0 percent to "dampen the fall in production and employment" due to the global financial crisis.

Repeated and sharp central bank cuts have failed so far to unfreeze the interbank lending crucial to business that ground to a halt after the US market for high-risk or subprime mortgages collapsed in mid-2007.

ECB officials had suggested last week they did not want to use up all their rate cutting options too quickly in case the recession drags on and markets had accordingly anticipated a half point cut.

In the event, the ECB clearly recognised "that we are not in ordinary times and that they cannot afford to keep the same range of policy moves," Bank of America economist Gilles Moec said.

The decision signals that "the best course of action is to go fast and deep, probably on the condition that the relaxation will be quickly taken back as soon as the first signs of recovery appear," Moec added.

"The ECB’s reluctance to cut by more than 75 basis points seems to stem from a desire to keep some ammunition back and also concern that too big a cut could hurt confidence," said economist Howard Archer at consultants IHS Global Insight.

The ECB still has ample room for manoeuvre with inflation falling from a record 4.0 percent in July to 2.1 percent last month. It is forecast to drop further as oil and food prices decrease.

The bank’s medium term inflation target is just below 2.0 percent.

Analysts suggest it could slash its benchmark lending rate to as low as 1.5 percent by March to boost the eurozone economy, which contracted in the second and third quarters and is expected to keep shrinking well into 2009.

European Union data confirmed Thursday that the eurozone economy was in its first official recession since the bloc was formed in 1999.

BNP Paribas economist Clemente De Lucia noted that "leading indicators of momentum in activity reported that bigger gross domestic product falls are likely in the coming quarters."

She said that "growth concerns are mounting" in particular because "the GDP breakdown showed that the weakness was broad-based."

The eurozone economy of 320 million people is set to expand to 16 members and add another 5.5 million when Slovakia joins in January.

ECB forecasts for growth and inflation are also to be released here later on Thursday as the ECB governing council holds one of two annual meetings in a eurozone capital.

During a press conference at which ECB president Jean-Claude Trichet is to explain the bank’s decision, analysts will listen for indications of whether the ECB is inclined to cut rates again in the near future.