By Kirsten Donovan
LONDON, Nov 4 (Reuters) - A sharply slowing euro zone economy has persuaded financial markets that the European Central Bank could slash interest rates by as much as 75 basis points this week to contain the fallout from the global financial crisis.
Figures derived from Euro Overnight Index Average (EONIA) rates show interest rate traders almost fully pricing in a three-quarters of a percentage point cut to 3.0 percent on Thursday.
If so, this would be the first time in its history that the ECB has moved rates by such a large amount. But despite the current futures market pricing, it would still be a surprise.
All 81 economists polled by Reuters last week, along with a majority of analysts, reckon the ECB will cut its base rate by a more modest 50 basis points to a two-year low of 3.25 percent.
"The market is salivating over what the ECB and Bank of England will do on Thursday," Calyon rate strategists said in a note. "We expect 50 basis points of cuts from each central bank, but the market pricing has increased to a 75 basis point move. We are in no doubt the accompanying messages will signal more easing to come."
President Jean-Claude Trichet has convinced markets that another ECB rate cut is a done deal, having already lowered them by 50 basis points last month in a coordinated move with other major central banks.
Trichet said last week that there is a possibility, although not a certainly, that rates would be cut at the Governing Council's next meeting.
Calyon strategist David Keeble says the ECB has no need to surprise the market on Thursday as the recent sense of panic is fading. After the euro suffered its biggest one month loss ever in October, Euribor interbank lending rates are easing and stock markets are basing out. "They have not signalled at all that they are going to move 75 basis points and if they do it will really unhinge expectations of futures moves," said Keeble.
MORE CUTS TO COME
Eonia futures price further easing, with rates eventually seen falling to a three-year low of 2.5 percent by April.
That is in marked contrast to a few months ago when even in the face of the global credit crunch, the ECB raised rates to 4.25 percent in June, stressing its inflation-fighting mandate.
But the European Commission said on Monday that the euro zone is already in a technical recession and economic growth will come to a virtual standstill next year.
With price pressures also receding -- oil for example has more than halved in price to below $70 a barrel -- the ECB has some much needed wiggle-room.
Five-year/5-year forward inflation breakevens -- a widely used measure of future inflation expectations also followed by the ECB -- have eased to 2.32 percent from 2.65 percent in early September and from a peak of 2.78 percent in late August, according to data from Calyon.
Nomura rates strategist Charles Diebel said the ECB wasn't expected to have the stomach for a 75 basis point cut on Thursday, but rates could ultimately test the lows seen between 2003 and 2005. "Our longer term view remains one where prior cycle lows will be tested, as they have in the U.S.. As such we would expect a move to 2 percent from the ECB into next year and for the BoE would suggest the prior cycle low of 3.5 percent will be exceeded," Diebel said.
UK interest rate futures also show the Bank of England easing rates 75 basis points this week, although again a broader Reuters survey of economists points to just a 50 basis point cut to 4 percent.