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Inflation

ECB cuts rates, launches asset purchases

The European Central Bank (ECB) surprised financial markets by cutting eurozone interest rates to a new historic low. It also plans to start asset buying program in October.

ECB slashes interest rates again

The European Central Bank (ECB) announced Thursday that the rate on commercial bank refinancing operations will be lowered by 10 basis points to 0.05 percent.

The ECB's rate-setting governing council also decided to lower the interest rate on its marginal lending facility by the same amount to 0.30 percent. Furthermore, it drove the overnight deposit rate deeper into negative territory, now charging banks 0.20 percent to park funds with it.

The measures reflect growing concern within the central bank about the health of the eurozone economy. After years of recession, the 18-nation bloc started to grow earlier this year. The recovery, however, is faltering with German output shrinking and the French economy stagnating in the second quarter.

Following Thursday's regular policy meeting, ECB President Mario Draghi told a news conference that the bank saw downside risks to the eurozone's economic outlook.

"In particular, the loss in economic momentum may dampen private investment, and heightened geopolitical risks could have a further negative impact on business and consumer confidence," he said.

As a result, the ECB President predicted slower eurozone growth of just 0.9 percent for this year, accelerating to 1.6 percent next year.

In an effort to halt the slowdown, Draghi also announced plans for ECB purchases of asset-backed securities and covered bonds to help ease credit conditions. He didn't elaborate on the size of the asset-buying program, but the Reuters news agency reported - citing an ECB source - that it could amount to 500 billion euros ($650 billion) over three years.

ECB's last arrow in the quiver

With interest rates virtually at zero percent, asset purchases are the last remaining option left for the ECB's monetary policy to spur the ailing economy in the currency bloc.

Banks create Asset-backed securities (ABS) by pooling mortgages as well as corporate, auto or credit card loans and selling them to insurers, pension funds and now even to the ECB. Covered bonds are similar instruments, but the underlying assets are protected so that if a bank goes bankrupt, the assets are still existing. That makes them safer than ABS.

The asset-buying program falls short of expectations that the ECB could emulate the US Federal Reserve's $85-billion (65-billion-euro) a month bond-buying scheme of 2009. Draghi noted, however, that monetary policy alone would not be able boost growth and bring annual inflation up to the bank's target of 2 percent.

"For doing that you need other things, fiscal policy, structural reforms first and foremost," he said

Deflation - When everything gets cheaper

Eurozone inflation is currently at a worryingly low level of 0.3 percent, with the threat of a deflationary cycle looming large. By lowering borrowing costs, the ECB is trying to encourage commercial banks to lend more to businesses and consumers. Asset purchases will boost the amount of money in circulation. The hope is that it will increase demand and economic growth, accelerating inflation.

ECB President Draghi revealed that the decisions taken by the governing council were not unanimous.

"Some governors were in favor of doing more, some were in favor of doing less," he said, adding that the measures were, nevertheless, agreed by a "comfortable majority."

uhe/sri (Reuters, dpa, AP)

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