European Central Bank Reveals Package to Strengthen Eurozone

ECB cuts interest rate to record low, driving borrowing costs down to near zero.

Mario Draghi, President of the European Central Bank, addresses the media during the ECB's monthly news conference in Frankfurt, Sept. 4, 2014.
Mario Draghi, President of the European Central Bank, addresses the media during the ECB's monthly news conference in Frankfurt, Sept. 4, 2014.Credit: AP

The European Central Bank cut interest rates to a fresh record low on Thursday, unexpectedly bringing borrowing costs close to zero to lift inflation from rock-bottom levels and support the stagnating eurozone economy.

The ECB cut its main refinancing rate to 0.05 percent from 0.15 percent previously and drove the overnight deposit rate deeper into negative territory, now charging banks 0.20 percent to park funds with it.

The lower rates will make the ECB's upcoming four-year loan offer, or TLTRO, more attractive as banks can now get the funds for less. But with lending still impaired, the wider impact may be questionable.

"It was the last chance to do that ahead of the TLTROs, that's probably why they did it," said Holger Sandte, analyst at Nordea. "To me, it looks a bit like panic, and it creates a lot of expectations for more to come in the press conference." Marco Valli, an economist with Unicredit, said the cut would have little impact on the European economy.

"We are speaking about a very tiny interest rate cut," he said. "They probably want to show that they won't just do rhetoric. But it will help only at the margins."

ECB President Mario Draghi is expected to give a more detailed assessment of the economy during his 1230 GMT news conference. Many analysts also expect him to clarify the ECB's plans to buy securitized loans to ease credit conditions. Plans to launch an asset-backed securities (ABS) and covered bond purchase programme worth up to 500 billion euros were on the table at Thursday's European Central Bank policy meeting, people familiar with the discussions told Reuters earlier on Thursday.

Draghi will likely announce such a program at his news conference unless it encountered strong opposition at the Governing Council's policy meeting. The program would have a duration of three years and comprise both ABS and covered bond purchases. The ECB could begin buying the assets this year, the people familiar with the discussions said.

Markets will also be listening for any hints about a possible large-scale asset purchase, or quantitative easing, program that also includes government debt. "If this is all they do, that's a disappointment to markets," Nordea's Sandte said.

Draghi ramped up expectations when, departing from the text of a speech, he told the Jackson Hole central bankers' conference on August 22 that markets had indicated inflation expectations showed "significant declines" in August. He said the ECB's Governing Council would acknowledge these developments and, within its mandate, "use all the available instruments" to deliver price stability over the medium term.

Eurozone inflation slowed to 0.3 percent in August, falling further below the ECB's target of just under 2 percent and raising the specter of deflation in the eurozone, where growth ground to a halt in the second quarter.

Draghi's problem is that the ECB is running out of ammunition with which to fight such low inflation. The one big weapon it retains is quantitative easing (QE) - essentially printing money to buy assets.

Though other central banks have used this tool, hawkish members of the ECB's 24-member policymaking council are resistant. An ECB source told Reuters last week that "the barrier to QE is still very high".

As well as hinting at further ECB policy action, Draghi used his Jackson Hole speech to urge governments to use fiscal policy and structural reforms to support the eurozone economy.

Many observers focused on Draghi's comment that there was scope for governments to use fiscal policies to help growth as the main message of the speech, but some - particularly in Germany - said his remarks had been misread. Draghi will get a chance to clarify his message at the news conference.

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