With economic activity in the euro zone "falling off a cliff", economists at Bank of America expect the European Central Bank to cut its main refinancing rate yet again at its meeting on Thursday.

"Although the ECB still seems reluctant to ease rates much further, we do expect the bad data to convince the ECB that a 50bp cut is required on January 15," Bank of America's Gilles Moec said.

Since the last ECB meeting, a number of data releases have suggested an intensification of the economic slowdown. In Germany, exports fell by a record 10.6% in the month to November, while both industrial orders and output continued to surprise to the downside over the same period.

The EU Commission released its euro zone economic confidence indicator and reported that stronger-than-expected pessimism pushed the sentiment indicator down to a record-low 67.1 for the month of December.

Furthermore, Eurostat reported that the unemployment rate in the monetary union rose to 7.8% in November, reflecting an increase of 202,000 unemployed persons compared to the previous month, while more recent data out of the larger euro zone suggests the labour market will only weaken further in the region.

Despite the weak figures, Moec also noted that recent ECB statements have suggested that the central bank may decide to hold rates at their present levels.

In an interview with the BBC on Dec. 9, ECB President Jean-Claude Trichet said that the central bank had already cut rates an unprecedented 175 basis points within a short period of time and that the reductions had yet to fully spill into the real economy. Less than a week later, Trichet warned that there are limits as to how far the ECB can bring down rates and said that the central bank needs to be wary of being trapped with rates too low.

"However, we maintain our view that a close look at recent data will elicit a 50bp cut on January 15, probably followed by a pause in February and a final 50bp cut to a record low of 1.5% in March," Moec said.

IDEAglobal economist Lorenzo Cella also noted the growing pressures on the ECB to cut rates further amid increasingly pessimistic data. "Nonetheless, the Frankfurt-based CB seems anything but inclined in slashing further its main refi rate, at least for the time being," Cella said. "To us, while such discrepancy undoubtedly reduces odds for the most extreme scenarios (no cut/75bps cut), it still favours a 50bps cut, with door still open for a more disappointing 25bps move."

Given the sharp declines in the most recent economic indicators and inflation estimates, Cella acknowledged that those on the ECB Governing Council pushing for aggressive cuts must have arguments in support of such a decision.

However, like Moec, Cella also noted recent statements out of the central bank suggesting that rate cuts could be put on hold as the ECB waits for previous cuts to be transmitted into the economy. Furthermore, Cella said that those on the council worried about "using all firepower at once" would need even more bad news regarding the economy before agreeing to more aggressive rate cuts.

"Both the usual ECB's modus operandi of a continuous search for broad-consensus among members and the recent dichotomy between awful economic data and conservative remarks from several ECB officials leave us with the impression that the Jan monetary policy meeting will once again culminate with a compromise decision," Cella said.

"In fact, if on the one hand, especially after recent economic data, the... central bank cannot afford to deeply disappoint EU politicians and market participants by maintaining rates steady, on the other hand we would be very surprised by an abrupt shift in its usual conservatory monetary policy approach," he added.

With the more extreme choices that could be taken on Thursday removed from the equation, the crucial question remaining is whether the central bank will cut by 50 basis points or 25.

"In our view odds are in favour of the former, as the magnitude of the reported deterioration in recent Eurozone economic data gains pace," Cella said. "The strong possibility the current economic downturn is even much steeper than the lower range of the latest ECB staff 2009 growth projection (-1% y/y), leaves the ECB with (little) room for conservatism."

While the majority of forecasts are calling for a rate cut of either 25 or 50 basis points, a select few are suggesting that the ECB could keep rates on hold at its upcoming meeting, including economists at Barclays Capital.

However, with increasingly negative data releases recently, the Barclays economists concede that the risk of further easing this Thursday is growing.

"At any rate, we can be reasonably confident that the policy rate will have been lowered by 50bp by the 5 February meeting (just four weeks away from now) and by more by the March meeting, taking the policy rate to under 2%,"

Barclays Capital economist Jullian Callow said.

"What's more, the ongoing drift of EONIA to a rate well below the policy rate reflects a closet easing - and one that is set, we think, to continue after the deposit facility rate is cut by 50bp on 21 January."

Therefore, even if the ECB does not lower rates on Thursday, Callow said that some easing in money market conditions can be expected as well as a signal of more to come in the post-decision press conference.

By Todd Wailoo, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Nancy Girgis, This email address is being protected from spam bots, you need Javascript enabled to view it

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