ECB cuts eurozone interest rate to zero to jump-start economy

European Central Bank also ramps up quantatitive easing programme in attempt to fend off deflation

The European Central Bank has surprised financial markets by cutting interest rates in the eurozone to zero, expanding its money printing programme and reducing a key deposit rate further into negative territory as it seeks to revive the economy and fend off deflation.

The ECB chief, Mario Draghi, implied interest rates would stay “very low” for at least another year but played down speculation they could be cut even further.

Unveiling a bigger package of help for the eurozone than investors had expected, Draghi predicted that inflation in the single currency bloc would remain stuck in negative territory over the coming months and cited a host of risks to economic growth from stumbling emerging economies, volatile financial markets and the slow pace of structural reforms.

“Rates will stay low, very low, for a long period of time and well past the horizon of our purchases,” Draghi said, referring to the ECB’s quantitative easing (QE) programme, where the bank pumps money into the European economy by buying bonds from banks, which is expected to run until at least March 2017.

But asked at a news conference how low the ECB could go on interest rates, he said: “From today’s perspective and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further. Of course, new facts can change the situation and the outlook.”

Going further than economists had expected, the Frankfurt-based ECB cut the eurozone’s main interest rate from 0.05% to zero, initially prompting a sharp drop in the euro against the pound and the dollar.

As part of a package of measures to revive lending and economic activity in the eurozone, the central bank cut its two other interest rates, expanded QE and announced new ultra-cheap four-year loans to banks, allowing them to borrow from the ECB at negative interest rates.

Eurozone GDP and inflation
Eurozone GDP and inflation

On currency markets, there were big swings in the euro as traders sought to establish if the ECB had now exhausted its options or if more stimulus was still to come. On stock markets, share prices were boosted when the rate cuts were announced but gains were cut as Draghi suggested there was no additional help to come.

Economists said the package of measures announced was more than had been expected.

“The European Central Bank announced a broad attack on below-target inflation, using all monetary policy tools at once to boost the economy and increase inflation,” said Tomas Holinka, economist at economic researchers Moody’s Analytics.

“While the bank has revealed its policy instruments step by step in the past, now it announced all of them – cutting the interest rates, expanding the QE programme and providing long-term liquidity – together.”

George Efstathopoulos, portfolio manager at fund manager Fidelity International, commented: “This is a bold stance from Draghi and the ECB, which should be positive for both financial markets but more importantly the real economy.”

As expected by markets, the deposit rate was cut by 10 basis points, further into negative territory to -0.4%. The latest cut in the deposit rate means the ECB will be charging banks more to hold their money overnight, with the aim of encouraging them to lend it to businesses. The marginal lending rate, paid by banks to borrow from the ECB overnight, was cut from 0.3% to to 0.25%.

The ECB expanded QE to €80bn (£61bn) a month, up from €60bn. That was more than the €70bn economists had been expecting, according to the consensus in a Reuters poll of economists. The programme will now include buying bonds issued by companies and not just by financial institutions.

Monetary policy decisions

— ECB (@ecb) March 10, 2016

The ECB had come under growing pressure to increase support for the eurozone’s flagging economy after the single currency bloc slipped back into negative inflation in February.

But the latest moves come amid growing scepticism on financial markets that central banks have enough ammunition left to bolster growth and stop falling prices becoming entrenched. The ECB itself is now predicting inflation in the eurozone will be just 0.1% this year, 1.3% in 2017 and 1.6% in 2018 - all under its target for inflation close to but below 2%.

Draghi echoed comments by his UK counterpart, Bank of England governor Mark Carney, that governments cannot leave central banks to do all the work on driving the economic recovery.

Draghi said: “Monetary policy is focused on maintaining price stability over the medium term and its accommodative stance supports economic activity. However, in order to reap the full benefits from our monetary policy measures, other policy areas must contribute decisively.”

Those comments reflected evidence that “the effectiveness of monetary policy is clearly diminishing”, said Alasdair Cavalla at the consultancy Centre for Economics and Business Research.

“Draghi threw down the gauntlet to fiscal policymakers, arguing for infrastructure spending while lowering the ECB’s own growth forecasts,” said Cavalla.

Against that backdrop of bleaker growth prospects and falling prices, Draghi had already indicated the central bank would announce fresh stimulus at the conclusion of this week’s policy-setting meeting.

Economists had widely expected the ECB to expand QE and cut the deposit rate so the reduction of the main interest rate and the marginal lending rate caught markets off-guard.

Alex Edwards, analyst at currency transfer company UKForex, said: “The ECB has delivered nothing more than dovish news. Rates were cut, inflation forecasts slashed and an extra $20bn announced in quantitative easing. Draghi has not left many stones unturned, and the fact he announced this all at once sent the euro spiralling downwards.

“The euro has been extremely volatile since Draghi spoke, and bounced back as quickly as it fell after he also hinted that rates may now be at their bottom. It’s going to be a very bumpy ride for the euro into the end of the week.”


Katie Allen

The GuardianTramp

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