European Central Bank Vice-President Lucas Papademos speaking at the ECB Central Banking Conference on Nov 13, 2008.

The European Central Bank is expected to cut its benchmark rate by at least 0.5% next week after plunges in Eurozone retail sales and economic confidence in November.

Economic sentiment in the 15-country Eurozone dived this month to its lowest point since August 1993, the European Commission reported on Thursday. Retail sales fell for a sixth straight month and with inflation falling fast, the ECB will be cut rates Thursday rates from 3.25%t to 2.75% or below.

A cut of say 1% is unlikely as on Tuesday, Lorenzo Bini Smaghi, a member of the ECB Executive Board, said policymakers risk being left like the cavalry in a spaghetti western, “surrounded, without any ammunition left” and should focus on restoring financial market confidence, a European Central Bank official said on Tuesday.

“As the great spaghetti westerns of our youth have taught us, the ‘goodies' win if they shoot first. But he also has to hit the target,” Bini Smaghi said in a speech in Madrid.“There is no scene more depressing than those in which the cavalry is surrounded, without any ammunition left.”

Budget stimulus measures could lead to higher savings and higher public debt, as experienced in Japan in the late 1990s, Bini Smaghi warned. With financial markets not functioning normally, interest rate cuts could have little impact on the real economy. “Restoring confidence in markets is the biggest contribution that the state can make to get the economy back on track.”

Earlier Tuesday in Venice, Bini Smaghi warned of the dangers in cutting interest rates too fast “if it is interpreted as a signal that the central bank has a more pessimistic assessment of the economy than market participants. It has been observed . . .that sharp reductions in policy rates have led to a deterioration of market sentiment.”

The latest Bloomberg Eurozone Retail Purchasing Managers' Index (PMI), based on a mid-month survey of economic conditions in the Eurozone retail sector, slumped from 44.3 in October to 40.6 in November, signaling the sixth consecutive monthly fall in retail sales and the largest decline recorded in the five-year history of the survey.

The Bloomberg Retail PMI provides data one month ahead of government-issued figures and is based on a survey of more than 1,000 retail executives in Germany, France and Italy.The latest findings showed that retailer margins fell at the fastest rate to date, as discounts were increasingly offered to boost disappointing sales. To compound the worsening picture of consumer demand, retailers expect sales targets to be missed by a wide margin in the crucial December trading period.

Sales fell at record rates in both Germany and Italy, while a more modest decline was recorded in France:

• Italy continued to record the steepest rate of decline in retail sales of the three countries covered by the PMI. The month-on-month sales index slipped to a new survey low of 28.5, from October's 34.8.

• Having eased slightly in the previous two months, the rate of decline in retail sales gathered pace in Germany to register the sharpest monthly drop yet recorded by the survey. The monthly sales index dropped sharply from 46.7 in October to 41.3.

• Sales were more resilient in France, but still fell overall for the second consecutive month. The index rose marginally to 48.7, from 48.5, signaling the weakest rate of decline of the three countries surveyed.

On a like-for-like stores basis, Eurozone retail sales dropped below levels of a year ago in November, to an extent exceeded once in the history of the survey (April 2008). The year-on-year sales index fell from 41.4 to 38.8. A new survey-record rate of decline was reported in Italy, while German retailers saw the fastest rate of contraction for four years. In contrast, sales were only marginally lower than a year ago in France.

The downturn in year-on-year sales was led by an acceleration in the rate of decline at autos & fuel retailers, to the steepest yet recorded by the survey. Italian retailers reported particular weakness in auto sales. Meanwhile, clothing & footwear saw the sharpest drop in sales in seven months. Of the broad sectors covered by the survey, only food & drink retailers reported an increase in year-on-year sales. The rate of growth eased to the lowest in the current seven-month sequence as sales revenues were affected by falling prices.

Sales against plans – targets missed to an extent exceeded only twice in survey history

The sales against targets index fell for the third month running in November, from 36.4 in October to 32.4, signaling the third-largest shortfall in sales values against targets recorded by the survey to date. Retailers generally blamed disappointing sales on a squeeze on consumer disposable income, reduced credit availability and a widespread reluctance to spend amid the deepening economic gloom and growing job insecurity.

All three countries reported that sales targets were missed by a wide margin. The greatest shortfall was again seen in Italy, where the index slumped to a record low of 19.0. By product sector, sales targets were missed to the largest extent for autos & fuel (a new record) followed by clothing & footwear and household goods respectively.

Expected sales next month – pessimism held steady at three-year low

Retailers were generally gloomy about prospects for the crucial Christmas trading period, as they had been regarding November sales. The expectations index held steady at a three-year low of 47.0, indicating that retailers anticipate targets to be missed next month. Italian retailers were the most pessimistic – expecting the largest shortfall against targets on record – followed closely by their German counterparts. In contrast, French retailers expect targets to be beaten in December.

By product sector, auto & fuel retailers expect to miss targets to the greatest extent yet recorded by the survey, with more modest disappointments against planned sales expected in the household goods and clothing & footwear sectors. Food & drink and pharmaceuticals retailers expect to beat targets in December.

Prices and margins – wholesale price inflation eased for fourth month in a row but margins still took a battering

The latest survey data signaled that retailers in the single currency area continued to pay higher prices for their goods in November, but that the rate of inflation had weakened for a fourth successive month. The prices index stood at 56.9, the lowest since February 2007. By sector, purchase prices rose steepest in food & drink, followed by pharmaceuticals and household goods respectively.

Retail sector margins remained under severe pressure in November, despite weaker increases in purchasing costs. The gross margins index hit a survey low of 38.1, indicative of a rapid rate of decline as consumer demand worsened further and targets were missed. Gross margins were down sharply across the three countries that make up the survey, again led by Italy. By sector, profits fell most sharply in autos & fuel.

Employment – Retailers cut staff levels for eighth month running

With sales falling on both the monthly and annual measures and margins under pressure, retailers across the euro zone pushed through further job cuts in November. The current period of decline in retail employment now extends to eight months with the latest sub-50 reading of 48.2. Italian retailers cut jobs at the sharpest rate, while Germany and France both posted modest losses in staff numbers.

Purchases of goods for resale declined for the fourth month running in November, the longest running sequence in three years. Moreover, the index fell to 44.1, equaling the survey low posted in August 2004 and indicative of an acceleration in the rate of contraction. Italian retailers cut purchases to the greatest extent.

A marginal decline in the level of goods held in stock by euro-zone retailers was registered in November (49.6), the third successive monthly contraction. Anecdotal evidence generally linked falling inventory volumes to lower purchases as the near-term outlook for sales remained subdued. Where stocks rose, this was usually linked to worse-than-expected sales. An overall rise in stocks was registered in the Italian retail sector.