Tuesday 6 December 2016

European Central Bank cuts main interest rate to 0%

Published 10/03/2016 | 13:11

The European Central Bank has cuts its main interest rate to 0%
The European Central Bank has cuts its main interest rate to 0%

The European Central Bank has cut all of its main interest rates including a surprise reduction in the main refinancing rate to 0% from 0.05%.

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It also reduced the interest rate on deposits held by banks at the central bank to minus 0.4% from minus 0.3%.

And it expanded its monthly bond-buying programme to 80 billion euro (£61.2 billion) a month from the previous 60 billion (£45.9 billion).

The bank's steps on most counts exceeded expectations among analysts, suggesting it was determined to have an impact and avoid the market disappointment to its December 3 meeting, when it was seen as having done less than it could have.

Stock markets surged after the ECB's announcement.

At Thursday's meeting, the central bank also a dded corporate bonds to the assets it can buy, expanding the potential scope of the purchase programme. It also a nnounced long-term cheap loans of up to four years to help support banks.

The negative rate on deposits - in essence, a tax on banks' excess funds - is an unusual step aimed at pushing banks to lend rather than leave money at the central bank.

More lending would promote growth and push up inflation from a worryingly low annual rate of minus 0.2%. The rate cut and the other measures to expand stimulus underline how far the ECB sees itself from achieving its goal of inflation of just under 2%.

The bond purchases are paid for by adding newly created money to banks' reserve accounts at the central bank, in the hope that the money will then find its way into the economy through more and cheaper loans. Increasing the money supply is one way to try to lift inflation.

Low or negative inflation has raised fears that Europe may become stuck in an economic quagmire known as deflation, in which stagnant prices weigh on wages, investment and economic growth for years.

And more trouble in Europe - just as it seems finally to be recovering from the debt crisis that led to bailouts in Greece and other countries - is the last thing the global economy needs.

Europe is a key market for major companies, from carmakers Ford and General Motors to technology companies Apple and Samsung. A slide in growth would compound woes from slowing growth in many parts of the world, particularly China.

Yet the ECB's cut of the deposit rate below zero - also deployed by central banks in Japan, Denmark, Switzerland and elsewhere - has raised fears of side-effects, in particular that it could dent bank profits. Weak banks are less likely to lend, defeating the purpose of the measure.

ECB head Mario Draghi said the stimulus includes measures to steady banks' finances and increase their ability to lend to businesses.

The ECB will hold four rounds of cheap loans, at zero interest. If banks lend more to companies, they could qualify for a reduction in the interest rate to as low as minus 0.4%.

Banks that lend more will be eligible to borrow more, Mr Draghi said.

"A bank that's very active in lending to the real economy can borrow more than a bank that focuses on other areas," he added.

The loans will run through as long as March 2021, bringing "certainty of financing" that should enable lending.

The boost for bank finances comes after sharp drops in the share prices of major European banks, amid worries about their profitability and ability to meet financial obligations.

The ECB also cut its inflation forecast for this year to 0.1% from 1% - a reduction that goes a long way to explaining why the bank announced a broader than anticipated package of stimulus measures for the 19-country eurozone economy.

In its latest quarterly forecasts, the ECB also suggested that inflation would remain below its goal of just under 2% over the coming years. In its first forecast for 2018, the ECB said inflation would only average 1.6%.

Mr Draghi said that inflation would be low or negative this year in light of falls in commodity and energy prices. He said the bank's broad package of measures is designed to prevent "second-round effects" across the eurozone, for example, in wage demands.

Mr Draghi said the package of measures will help get inflation towards target in coming years.

Press Association

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