ECB Cuts Interest Rates in Bid to Boost Eurozone Inflation

Published June 05, 2014

| Reuters

The European Central Bank launched a raft of measures on Thursday to fight low inflation and boost the euro zone economy, cutting rates, imposing negative interest rates on its overnight depositors and offering banks new long-term funds.

The ECB cut all its main rates to record lows in a drive to fight off the risk of Japan-like deflation and bring down the euro's exchange rate. For the first time, it will charge banks 0.10 percent for parking funds at the central bank overnight.

It stopped short of large-scale asset purchases known as quantitative easing for now, but ECB President Mario Draghi said more action would come it necessary.

Draghi outlined a four-year 400 billion euro ($544.86 billion) scheme giving banks that have been holding back credit due to looming stress tests an incentive to increase lending to businesses in the euro zone.

"Now we are in a completely different world," Draghi told a news conference, citing "low inflation, a weak recovery and weak monetary and credit dynamics".

The package, adopted unanimously, was aimed at increasing lending to the "real economy", he said.

Other steps included extending the duration of unlimited cheap liquidity for euro zone banks, injecting about 170 billion euros by stopping tenders that withdrew funds spent on past government bond purchases, and preparing for possible future purchases of asset-backed securities to support small business.

Projections published by the ECB showed inflation would be just 0.7 percent this year, 1.1 percent next year and 1.4 percent in 2016, a downward revision and far below the ECB's target of below-but-close-to 2 percent.

"If required, we will act swiftly with further monetary policy easing," he said, adding that the policy-setting Governing Council was unanimous in its commitment to use unconventional instruments if needed "to further address risks of too prolonged a period of low inflation".

Financial markets saluted the ECB measures, even though most of them had been widely anticipated for weeks. The euro fell to a four-month low of $1.3505, down about one cent, after his statement. European shares rose and yields on the government bonds of stressed euro zone countries fell.

FRANCE HAPPY, GERMANY SILENT

French President Francois Hollande, who has been calling for months for ECB action to weaken the euro's exchange rate, which Paris argues is holding back economic recovery, welcomed the central bank's decision.

German Chancellor Angela Merkel declined comment, noting that the ECB took its decisions independently of governments. Her finance minister, Wolfgang Schaeuble, said low interest rates were not a long-term solution.

Low rates are unpopular in Germany, Europe's biggest economy, because they are seen as penalizing savers.

Conservative German economist Hans-Werner Sinn of the Ifo institute said the ECB's moves smacked of desperation and would not work.

"This is a desperate attempt, with ever cheaper money and penalty rates on deposits, to shift capital flows to southern Europe in order to stimulate growth there," he said.

Draghi said interest rates would stay low for a prolonged period but after Thursday's cut, he omitted a previous regular line that they could go lower.

Asked how long it would take for the measures to work their way though into the economy, he said: "Most likely we will see immediate effects in the money markets and we will see delayed effects in the real economy attributable to this program ... It will probably take three or four quarters."

The ECB lowered the deposit rate to -0.1 percent. It cut its main refinancing rate to 0.15 percent, and the marginal lending rate - or emergency borrowing rate - to 0.40 percent.

Economists polled by Reuters had expected a bigger cut in the refinancing rate to 0.10 percent from 0.25 percent.

Just hours before the ECB policy decision, a Bank of Japan policymaker sounded a warning, saying the euro zone should not take lightly the potential danger of slipping into a Japan-style deflationary period.

In an April 24 speech, Draghi set out three broad scenarios for ECB policy action and included the possibility of a broad-based asset-purchase program in the event of a worsening of the medium-term inflation outlook.

QE ON THE SHELF

Euro zone inflation has been stuck in what Draghi has called "the danger zone" below 1 percent since October, mainly because of weaker commodity and food prices, but also because of wage and other adjustments in euro zone crisis countries.

The stronger euro exchange rate exacerbates these dynamics.

At the same time, record low interest rates are still not feeding through evenly to companies across the currency bloc. Companies in Portugal, for example, are paying on average 5.4 percent on loans compared with 2.2 percent in Finland or France.

This particularly affects smaller companies, which rely strongly on bank funding and make up the bulk of the economy. ($1 = 0.7341 Euros)

URL

http://www.foxbusiness.com/economy-policy/2014/06/05/ecb-cuts-interest-rates-in-bid-to-boost-eurozone-inflation/