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ECB surprises markets by cutting eurozone interest rates to 0.25% ECB surprises markets by cutting eurozone interest rates to 0.25%
(about 3 hours later)
Borrowers across the struggling eurozone economies received an unexpected fillip on Thursday when the European Central Bank cut interest rates by a quarter of a percentage point, in a bid to stave off a slide into deflation. Borrowers across the struggling eurozone economies received an unexpected fillip on Thursday when the European Central Bank cut interest rates to a fresh record low, in a bid to stave off a slide into deflation.
After its monthly policy meeting in Frankfurt, the ECB's governing council announced that it would reduce its key refinancing rate to 0.25%, from 0.5%.After its monthly policy meeting in Frankfurt, the ECB's governing council announced that it would reduce its key refinancing rate to 0.25%, from 0.5%.
Mario Draghi, the ECB's president, who will explain the bank's decision at his regular press conference later on Thursday, had been expected to leave rates unchanged. While the economy of the 18-member single currency area clambered out of recession earlier this year, Mario Draghi, the ECB's president, warned that the outlook could deteriorate in the coming months.
But with inflation running well below the ECB's 2% target, at just 0.7% in October, a growing number of analysts have started to warn that deflation – which can be disastrous for economies carrying a heavy debt burden – is a real threat. "The risks surrounding the economic outlook for the euro area continue to be on the downside," he said. "Developments in global money and financial market conditions and related uncertainties may have the potential to negatively affect economic conditions. Other downside risks include higher commodity prices, weaker than expected domestic demand and export growth, and slow or insufficient implementation of structural reforms in euro area countries."
The recent strength of the euro against the dollar, which has tended to weaken since the Federal Reserve mooted the idea of "tapering" its $85bn (£52bn) a month quantitative easing programme, has also raised fears in some euro member-countries about the competitiveness of the zone's exports on world markets. As well as the rate cut, which took financial markets by surprise, Draghi said the ECB would continue making low-cost loans to eurozone banks until at least mid-2015, to try to prevent the financial sector from seizing up.
The euro was down by more than 1% against most major currencies after Thursday's announcement, hitting a seven-week low of $1.3375 against the dollar. Howard Archer, of consultancy IHS Global Insight, said: "The fact that the ECB chose to act now rather than wait until December when the governing council will have the ECB staff's new eurozone GDP and consumer price inflation forecasts suggests that the bank felt there was a compelling case for prompt action."
The muted strength of the economic recovery in many eurozone countries is also likely to have been a factor influencing the ECB's decision: earlier this week, the European commission revised down its expectation for growth across the 18 member-countries to just 1.1% in 2014. With inflation running well below the ECB's 2% target, at just 0.7% in October, a growing number of analysts have started to warn that deflation – which can be disastrous for economies carrying a heavy debt burden, as prices and wages fall while debt-levels remain fixed – is a real threat. Draghi suggested at his press conference that, "we may experience a prolonged period of low inflation".
"The fact that the ECB chose to act now rather than wait until December when the governing council will have the ECB staff's new eurozone GDP and consumer price inflation forecasts suggests that the bank felt there was a compelling case for prompt action," said Howard Archer, of consultancy IHS Global Insight. The recent strength of the euro against the dollar has also raised fears in some member-countries about the competitiveness of the zone's exports on world markets. The euro was down by more than 1% against most major currencies after Thursday's announcement, hitting a seven-week low of $1.3375 against the dollar.Italian prime minister Enrico Letta, speaking on a visit to Dublin, described the ECB's decision as "great news", adding that, "it shows the ECB cares about growth and competitiveness in Europe". The International Monetary Fund also welcomed the move. "The decision is fully warranted by the weak inflation dynamics and substantial slack in the economy," said spokesman Gerry Rice.
However, the ECB's move is unlikely to prove popular in Germany, where the Bundesbank – whose president, Jens Weidmann, sits on the ECB's governing council – has tended to take a traditionally hawkish stance, opposing some of the ECB's recession-busting measures. The muted strength of the economic recovery in many eurozone countries is likely to have been another factor influencing the ECB's decision: earlier this week, the European commission revised down its expectation for growth across the 18 member-countries to just 1.1% in 2014. Nevertheless, Draghi insisted at his Frankfurt press conference that the "fundamentals" of the eurozone are, "probably the strongest in the world".
The ECB, which has so far only released a brief statement, appears to have decided to postpone other, more unconventional measures, such as a repeat of its so-called Long Term Repo Operation (LTRO), offering cheap loans to struggling banks, in favour of a straightforward rate cut. Thursday's reduction was the fifth since Draghi took over from the more orthodox Jean-Claude Trichet in 2011. However, some analysts warned that the rate cut should be no substitute for the urgent reforms the eurozone needs to secure recovery and tackle the legacy of unmanageable government debts. "It's a palliative: a legal high," said Danny Gabay, of City consultancy Fathom. "They need to get on with the really important stuff: fiscal union, banking reform, debt mutualisation."
The ECB's suprise decision followed an earlier announcement from the Bank of England that it will leave its own interest rate unchanged at 0.5%, and the total value of assets held under QE at £375bn. The ECB's move is unlikely to prove popular in Germany, where the Bundesbank – whose president, Jens Weidmann, sits on the ECB's governing council – has tended to take a hawkish stance, opposing some of the ECB's recession-busting measures. Draghi admitted that Thursday's decision had not been unanimous, saying the governing council was, "wholly in agreement about the need to act, but there were disagreements about when to act". The suprise rate cut was the fifth since Draghi took over from the more orthodox Jean-Claude Trichet in 2011.
The decision followed an earlier announcement from the Bank of England that it will leave its own interest rate unchanged at 0.5%, and the total value of assets held under QE at £375bn.
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