European Central Bank Cuts Rates to near-zero

The European Central Bank (ECB) surprised markets by cutting its main interest rate to nearly zero, to prevent the faltering eurozone economies from slipping back into recession and to ward off the growing prospect of deflation.

The rate at which the ECB issues short-term loans to banks was cut to 0.05% from 0.15%, marking a new record low. The central bank also increased the fee it imposes on banks to store money at the ECB, to 0.2% from 0.1%. The so-called negative deposit rate, which it first imposed in June, has already pushed some market interest rates below zero.

Stocks rose in response to the announcement amid speculation that the ECB would later announce plans to buy bundles of bank loans known as asset-backed securities, in a further bid to stimulate lending.

Many economists have said that the ECB should have followed the lead of the US Federal Reserve and the Bank of England (BoE) – which both introduced a quantitative easing (QE) programme back in 2009 – to ward off the threat of deflation, a downward spiral of prices that can lead to high unemployment.

Annual inflation in the eurozone was 0.3% in August, according to an official estimate, well below the ECB’s target of about 2%.

However, a policy of QE could prove more difficult and risky in Europe, because of the region’s fragmented bond market. In addition, many people in countries such as Germany regard purchases of government bonds to be a violation of the ECB’s charter.

Analysts suggested that the ECB’s latest rate cut is probably too small to have much effect on market interest rates and may be designed instead to make the lending programme more attractive to banks. The interest on the four-year loans from the central bank is the same as the benchmark rate plus 0.1 of a percentage point. The cut means that the interest on the loans will fall to 0.15%.

The ECB last cut the main interest rate in June, to 0.15% from 0.25%, when it also introduced a 0.1% penalty on money that commercial banks deposit at the central bank. That so-called negative interest rate – now pushed to 0.2% – has helped push down market interest rates on some government bonds and money markets below zero, but the cheap money has not yet found its way to struggling businesses in countries such as Italy and Portugal.

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