ECB cuts interest rates to new low to keep recovery on track
THE EUROPEAN Central Bank (ECB) has cut interest rates to a new record low and said it would prime banks with liquidity into 2015 to prevent the eurozone's recovery from stalling as inflation tumbles.
The move took financial markets by surprise – the euro fell sharply in response while European shares rose.
The 23-man Governing Council had faced intense scrutiny after a shock slump in eurozone inflation to 0.7pc in October, far below the ECB target of just under 2pc.
"We may experience a prolonged period of low inflation to be followed by gradual upward movements towards an inflation rate of below but close to 2pc later on," said ECB President Mario Draghi.
The ECB cut its main refinancing rate by 25 basis points to 0.25pc. It held the deposit rate it pays on bank deposits at zero and cut its emergency borrowing rate to 0.75pc from 1.00pc.
"We have a whole range of instruments to activate before reaching the lower bound... in principle we could even cut further the interest rate," Draghi said.
Calls from eurozone government ministers and industry for the ECB to loosen policy to help bring down the euro's exchange rate had also heaped pressure on the council, though few analysts had expected a move this month. Euro policymakers have played down the threat of Japan-style deflation, which led to a "lost decade" there, but appear to be taking no chances.
Mr Draghi said there was general agreement on the need to act, but there were differences over when to act.
"Deflationary risks and the stronger euro seem to have motivated the ECB's move. It is obvious that the ECB, under Mr Draghi, has become much more pro-active than under any of his predecessors," said ING economist Carsten Brzeski.
The euro slid more than 1pc to hit a seven-week low of $1.33 (€0.99), down from around $1.35 just before the ECB announcement.
Mr Draghi reaffirmed the central bank's forward guidance that rates would hold at "present or lower levels" for an extended period and said he saw no threat of broad deflation.
He also said banks would be able to rely on as much liquidity as they needed for longer, with the bank's main refinancing operations to be offered at fixed rate with "full allotment" at least until July 2015.
European bank shares climbed.
Adding to the ECB's dilemma over how to support a fragile recovery has been a fall in excess liquidity – cash beyond what lenders need to cover day-to-day operations – as banks repay three-year ECB loans, known as LTROs, early before a health check next year.