The European Central Bank will probably cut interest rates as the chance of a recession in the euro zone has risen to 50 percent, Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., said in an interview.

“I would expect the ECB to change course,” he said. “They’re going to be pushed to do so.”

The ECB has raised its benchmark interest rate twice this year, taking it to 1.5 percent, in an effort to keep inflation expectations in check. ECB President Jean-Claude Trichet told the European Parliament on Aug. 29 that the bank is reviewing its assessment of price risks after growth in the euro area slowed. 

El-Erian, whose Newport Beach, California-based company runs the world’s biggest bond fund, said there’s “definitely” a risk that Europe will drag the rest of the world economy into a recession. He put the odds of another contraction in the U.S. at somewhere between 33 percent and 50 percent.

Growth in the 17-nation euro area slowed to 0.2 percent in the second quarter from 0.8 percent in the first ― with the German economy almost grinding to a halt ― as Europe’s debt crisis roiled financial markets and weighed on confidence.

The PIMCO executive and former International Monetary Fund official likened the financial turmoil in Europe to the subprime crisis in the U.S. Just as what happened in America, troubles that began in a small part of the economy with questions about Greece’s finances in 2009 are spreading elsewhere.

“The dynamics are very similar to what we saw here,” El- Erian said.

Spain’s five-year bonds fell for a fourth day Thursday as demand waned at an auction of the securities, deepening concern that ECB purchases to stem the debt crisis won’t be enough to support the market.

The ECB, which is barred legally from buying bonds directly from governments, has restrained Italian and Spanish borrowing costs for three weeks through purchases in the secondary market. Contagion from the debt crisis sent both nations’ 10-year yields to euro-era records almost a month ago.

The central bank “has gone from being a part of the solution to being part of the problem because it now has a lot of this debt on its balance sheet,” El-Erian said. If the debt is restructured, the ECB will “take a hit and will most likely have to raise capital,” he added.

The approach that European policy makers have taken in response to the region’s economic emergency is akin to “rolling a snowball down a hill,” according to El-Erian.

“The problems get bigger and the dynamics get more disorderly,” he explained. “That is what is going to occur if they continue with these ad-hoc solutions.”

So far, the rescue bill in Europe includes 365 billion euros ($518 billion) in official loans to Greece, Portugal and Ireland, the creation of a 440 billion euro fund as well as the bond purchases by the ECB. (Bloomberg)









The failure of those steps to bring the crisis to an end has sapped business and household confidence. The European Commission’s index of executive and consumer sentiment fell last month to 98.3 from 103, its biggest drop since December 2008, three months after the collapse of Lehman Brothers Holdings Inc. (Bloomberg)