Draghi sees euro zone recession ahead

Euro Zone: The European Central Bank's new president cuts interest rates and predicts a recession for the union before the end of the year.

Mario Draghi, the ECB president, cut interest rates to 1.25 per cent yesterday in his first policy meeting in charge. Kai Pfaffenbach / Reuters

The new president of the European Central Bank cut interest rates yesterday and predicted the euro zone would be in recession by the end of the year as the future of the bloc hung in the balance.

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In his first test as the new chief, Mario Draghi reduced rates to 1.25 per cent from 1.5 per cent and predicted inflation would hover at 2 per cent in the euro zone in the long term, dampened by weak growth. "What we are observing is slower growth heading towards a mild recession by year end," said Mr Draghi.

"The weakening of the business cycle will by itself have a dampening effect on wages, prices, costs ... and inflation." Bankers this week warned if Europe went back into recession, the UAE would not avoid being affected by the fallout.

Mr Draghi said the European Central Bank (ECB) would not act as a "lender of last resort" to European governments in order to maintain the stability of the euro zone.

The ECB had previously raised interest rates from 1.25 per cent to 1.5 per cent in July in response to concerns about rising inflation. Mr Draghi took over as president of the bank in the week, replacing Jean-Claude Trichet, who held the post for eight years.

Mr Draghi said the prospect of Greece leaving the euro zone was not something he could "conceive" because it was not in the original treaty signed by governments when the currency bloc was formed.

"It's not in the treaty. We are all bound by the treaty," he said.

The International Monetary Fund said it backed the interest rate cut and that its aid to Greece was tied to the country, not a specific government.

Greek prime minister George Papandreou stunned world markets on Tuesday by calling for a referendum on a deal to cut the country's debts. But last night he softened his stance, offering to hold talks with the opposition to reach a consensus and avoid a popular vote, as the government teetered on the brink of collapse.

Members of Mr Papandreou's government had earlier called for his resignation and Evangelos Venizelos, the finance minister, denounced his call for a referendum.

"Having an immediate picture of the situation in Europe and around the world. I have a duty to tell the Greek people the full and simple truth.

"If we want to protect the country we must, under conditions of national unity and political seriousness and consensus, implement without any delay [the agreed EU bailout]," said Mr Venizelos.

A euro-zone agreement had been made to write off half of Greece's bank debts, increase the size of a recently established European bailout fund and recapitalise banks.

Nicolas Sarkozy, the French president, and Angela Merkel, the German chancellor, had responded to the call for a referendum by saying Greece would not receive a cent of the proposed €8 billion (Dh40.46bn) bailout before the referendum was resolved. "Greece had the prospect of €8bn, which it has now forfeited," said Jean-Claude Juncker, who heads the EuroGroup of euro-zone finance ministers. "I am of the view that we have to do everything possible to help Greece. That's why we'll continue to work on this, but what's more important is that we erect so-called fire protection walls to avoid the Greek crisis moving to Italy, Spain, Portugal and Ireland."

Andrew Scott, a professor of economics at the London Business School, said the Greek people should be allowed to decide between 20 years of adjustment and loss of control under the EU bailout package or two years of "acute, awful pain" as it leaves the euro.

"I think it's right that the home of democracy asks which of these two channels they want to do," he said.

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