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Rate cuts may face stiff resistance at ECB

By Marc Jones

FRANKFURT (Reuters) - The European Central Bank may have abandoned any hope it still harbored of being able to hike interest rates, but it may take more than a mild dose of recession for it to do a complete U-turn and start cutting rates again.

ECB President Jean-Claude Trichet cemented the view that rate hikes are now off the table on Monday, telling the European Parliament that the bank's inflation view was "under study" rather than using its long-held line of risks being "to the upside."

Accompanied by new, more downbeat economic forecasts from the bank's in-house economists, it is likely to lead to an official toning down of the ECB's inflation prognosis at its meeting next Thursday.

The shift would signal its previous rate hike plans had been put on hold, but financial markets are betting it is the first step toward it doing a complete back flip and cutting rates again, despite the obvious damage it could do to its credibility having hiked rates only in April.

Three-month Euribor futures -- one of the main gauges of market expectations -- show rates being cut to 1.25 percent as early as December and easing even further after that. They are not expected to return to their current 1.5 percent level until mid-2013.

Economists -- who were behind markets in abandoning rate hike expectations -- are yet to be convinced. With rates still extremely low even after this year's two increases, Deutsche Bank economist Mark Wall sees only two scenarios where the ECB would consider easing policy again.

"One is where a major shock causes a seizure in financial markets similar to what we saw with Lehman Brothers. Despite the financial market stresses, it is not equivalent to Lehman's," he said.

"The other scenario is where they see a real risk of a return to recession."

A slump in economic data over recent weeks has seen analysts hike the chances of recession, although for most it is still not their baseline assumption.

Rabobank puts the risk at 60 percent but also points out that the breakneck pace at which key, forward-looking PMI data has slumped in recent months bears a worrying resemblance to what happened after Lehman collapsed in September 2008.

The ECB also seems to see recession as unlikely. While Trichet signaled the bank's inflation view could change in his statement in Brussels on Monday, he kept its long-hold view that growth will continue, albeit at a moderate pace.

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