By Gabi Thesing Dec. 11 (Bloomberg) -- The European Central Bank said the euro-region economy may start to recover in the second half of next year and Executive Board member Juergen Stark signaled the bank is reluctant to keep cutting interest rates aggressively. “Global economic weakness and very sluggish domestic demand are seen as persisting in the next few quarters,” the Frankfurt- based central bank said in its monthly bulletin published today. “A subsequent recovery should then gradually take place, supported by the fall in commodity prices and assuming that the external environment improves and the financial tensions weaken.” The ECB last week delivered the biggest interest-rate cut in its ten-year history, lowering its benchmark by 75 basis points to 2.5 percent to contain fallout from the global financial crisis. Stark said last night that the scope for further reductions is “very limited, potentially allowing for small steps only.” The Swiss National Bank today halved its benchmark rate to 0.5 percent and the Bank of Korea cut its key rate by a percentage point to 3 percent. The U.S. Federal Reserve has lowered its benchmark by 325 basis points this year to 1 percent. Investors are betting the ECB will lower rates by a further 50 basis points at its next policy meeting on Jan. 15, Eonia forward contracts show, even as policy makers strike a more cautious tone. ECB council member Yves Mersch said last week that rate reductions of 25 basis points are more likely in future, and ECB President Jean-Claude Trichet has said he wants to avoid being “trapped” by rates that are “too low.” ‘Protesting’ Expectations Stark, speaking in Tuebingen, Germany, last night, suggested the ECB won’t necessarily cut rates again next month. New information needed for a “serious re-assessment of the outlook for price stability will very likely not be available before February or March,” he said. The ECB’s “appropriate” monetary-policy stance “depends exclusively on its assessment of the balance of risks to price stability and nothing else.” ECB council member Erkki Liikanen said in Helsinki today that, while risks to the growth outlook are currently on the downside, “when the economy starts to recover, we must bring interest rates up quickly too to combat inflation.” “The ECB is protesting market expectations of further easing,” said Julian Callow, chief European economist at Barclays Capital in London. Still, “given the economic and inflation environment for now, the euro-area economy will need aggressive further easing in monetary policy to enable it to recover.” Slowing Inflation The ECB forecasts the economy will contract about 0.5 percent next year, which would be the first full-year decline in gross domestic product since 1993. The bank said today that “the level of uncertainty remains exceptionally high.” Oil prices have collapsed to $45 a barrel from a record $147 in July. The inflation rate fell the most in almost 20 years last month, to 2.1 percent from 3.2 percent in October. The ECB “has observed increased evidence that inflationary pressures are diminishing further, and, looking forward, inflation rates are expected to be in line with price stability over the policy-relevant horizon,” the ECB said in the bulletin, which echoes Trichet’s Dec. 4 policy statement. The bank expects inflation to average about 1.4 percent in 2009 and 1.8 percent and 2010. It aims to keep the rate just below 2 percent. Depending on future oil and commodity price developments, a “faster” drop in inflation rates “cannot be excluded around the middle of next year,” the ECB said. Still, any “sharp fall in HICP inflation should be short-lived and is therefore not relevant from a monetary policy perspective,” it added. Stark said there may be “negative inflation rates for a couple of months in some regions of the euro area” next year. At the same time, “upside tail-risks to inflation receive less attention” than fears about potential deflation “but may be more relevant and a stronger source of concern in the medium to longer term,” he said. To contact the reporter on this story: Gabi Thesing in Frankfurt at gthesing@bloomberg.net

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