European Central Bank policymakers are hinting there is room for cheaper credit in the euro zone if confidence falters, opening the door to a possible interest rate cut next week.
ECB President Jean-Claude Trichet aroused market speculation of a rate cut after he said the central bank will reassess its outlook for gradual economic recovery if euro zone consumer spending fails to pick up.
"We are vigilant and alert," he said in an interview with the German business daily Handelsblatt released on Tuesday.
"In case our expectations for stronger household consumption and overall domestic demand were not to materialize, we would work out our assessment accordingly, fully in line with our monetary policy strategy," he said, when asked about the risks to the ECB's forecast of a gradual pickup.
ECB policymakers have said repeatedly that the current 2.0 percent interest rate is not obstructing recovery. But in recent weeks they have begun to express concern that recovery might falter if euro zone citizens, worried by the threat of unemployment, continue to hold back on spending.
Trichet's softening tone, following mounting concerns uttered by other ECB policymakers since the Madrid bombings, heightened expectations the ECB may cut its official interest rates at its April 1 policy meeting.
Euro zone government debt yields fell to nine-month lows following the comments from Trichet and other ECB policymakers.
Euribor interest rate futures, a market barometer of euro zone rate expectations, which were already pricing in a good chance of a cut, are now attaching a more than 50 percent probability to a 25 basis points rate cut by June.
But Frederic Pretet, senior European Economist at Credit Agricole Indosuez, thought a cut might come as soon as April 1.
"It's a tradition that 10 days before a policy meeting, the president delivers a speech and others back the view and we get these kind of comments that they have room to maneuver," he said. "We are in the same situation. It is a repeat of the past which confirms our view that it is going to be a close call for next week's meeting."
The euro reacted by falling a third of a percent to $1.2292 and three quarters of a percent to 130.51 yen, its lowest since early December.
"Trichet's comments confirm the ECB's recent stance of being careful not to exclude a rate cut possibility. By hinting rates might be cut, the ECB is trying to deflect any upward pressure on the euro," said Mary Davis, global currency strategist at Credit Suisse First Boston.
While Trichet has not sent a decisive signal, at the very least analysts see the central bank preparing the ground for a rate cut should the economy weaken further.
"Right now official comments could be treated as consistent with a cut, but the data flow does not seem to support this. So on balance, (there will be) no cut but a flexible future stance," said Julian Callow, euro zone economist at Barclays Capital in London.
ECB Governing Council members Guy Quaden of Belgium and Matti Louekoski of Finland both said on Wednesday they see a gradual euro zone pick up as the most likely scenario. But Quaden added that even with interest rates at record lows, the central bank has kept itself some room to maneuver if needed.
"It's true that we still have some ammunition if the outlook on inflation allowed and the outlook for economic activity made it desirable," Quaden said in an interview in the French newspaper Le Monde.
Louekoski also said that the Madrid bombings, which killed over 190 people early in the month, "will add uncertainty which in itself could have a negative additional impact on growth."