Jan. 19 (Bloomberg) -- European Central Bank council member George Provopoulos said the scope for further interest-rate reductions is “limited” and markets would be wrong to bet on the benchmark dropping to 1 percent.

While there is still “room to maneuver” on rates, “if the markets should be expecting us to cut as far as 1 percent or even lower, this is something different,” Provopoulos, who heads the Greek central bank, said in a Jan. 16 interview in Athens. “We have given no such indication. The scope for further cuts will be limited.”

Economists at Citigroup Inc. last week predicted the ECB will lower its key rate to 0.5 percent this year, and Eonia forward contracts show some investors are betting it will drop as low as 1 percent. The ECB on Jan. 15 cut the benchmark by half a percentage point to 2 percent, matching a record low. President Jean-Claude Trichet signaled the bank may reduce borrowing costs again in March.

While Provopoulos didn’t rule out another half-point move, he indicated the ECB’s stomach for aggressive cuts is weakening. After 2.25 percentage points of easing since October, interest rates are “already at very low levels,” implying that “at some point in the future, moves take place in small steps,” he said.

The remarks are “unusually explicit” and a “clear indication that the ECB is slowing down the pace of its monetary policy easing,” said Laurent Bilke, an economist at Nomura International in London, who predicts the key rate will bottom out at 1.5 percent. “The ECB doesn’t want to follow the Federal Reserve or the Bank of Japan.”

‘Shockingly Poor’

Citigroup’s chief euro-area economist Juergen Michels cited “shockingly poor” economic data for the downward revision to his forecast for ECB rates. He expects the economy of the 16 euro nations to shrink at least 1.5 percent this year.

The European Commission today forecast the euro-area economy will shrink 1.9 percent this year, revising a November estimate for growth of 0.1 percent. The ECB in December projected a contraction of about 0.5 percent.

Greece is feeling the impact of Europe’s slowdown. Standard & Poor’s last week lowered the country’s sovereign credit rating one level to A-, saying the global financial crisis has “exacerbated an underlying loss of competitiveness” in the euro region’s eighth biggest economy. The ratings of Ireland, Portugal and Spain are also under threat.

Downward Revisions?

Provopoulos, 58, said he “cannot exclude” downward revisions to the ECB’s growth and inflation forecasts.

Still, he reiterated the bank’s view that “the euro-area economy will begin to gradually recover around the end of this year or in early 2010,” supported by lower borrowing costs, cheaper oil and increased government spending.

In taking the decision to lower rates last week, the ECB had “already anticipated a certain degree of deterioration” in the economy, Provopoulos said. “Any further action will be based on whether the situation deteriorates more than expected.”

The Fed, the Bank of England and the Swiss central bank have reduced borrowing costs more aggressively than the ECB as the world’s largest economies slide simultaneously into recession for the first time since World War II.

The Bank of England on Jan. 8 cut its main lending rate to 1.5 percent, the lowest since the bank was founded in 1694. The Fed last month lowered its key rate to a target range of zero to 0.25 percent. Japanese and Swiss rates are also close to zero.

Caution

“I’m not excluding further reductions if inflation prospects warrant such reductions,” Provopoulos said. “But I should caution in the sense that some people interpret this as interest rates going close to zero, which is not true in our case.”

Inflation slowed to 1.6 percent in December. The rate, which the ECB aims to keep just below 2 percent, may drop to “very low levels” this year, the ECB said last week.

“Although we could see negative inflation rates in some regions of the euro area for very short periods toward the middle of the year, we clearly do not expect deflation,” Provopoulos said. “After reaching a trough in the summer months, we should see a pickup in the inflation rate.”

To contact the reporters on this story: Christian Vits in Athens at cvits@bloomberg.net; Christos Ziotis in Athens through the Athens newsroom at +30- cziotis@bloomberg.net

Last Updated: January 19, 2009 06:02 EST