ECB Cuts Rates to 1.25%

The European Central Bank has cut official interest rates further as it steps up its efforts to combat Europe’s recession, but it has stopped short of entering zero interest rate territory., Financial Times 4/2/2009 5:00:29 AM

The ECB said its main policy interest rate would fall from 1.5 per cent to 1.25 per cent, the lowest ever. The cut was smaller than financial markets expected. But it sends a signal that the central bank remains wary of following the example of the US Federal Reserve, which has cut official interest rates to virtually zero.

A larger cut in the main policy rate would have forced the ECB to lower its deposit facility” rate from 0.5 per cent to zero. The deposit facility is used by banks to park funds at the ECB overnight, and with the central bank flooding the market with liquidity, the deposit facility rate has become an important benchmark for market interest rates.

The ECB has become increasingly concerned about the likely depth and duration of the eurozone’s recession, already the worst seen in continental Europe since the second world war. Annual eurozone inflation, at just 0.6 per cent in March, is also undershooting the ECB’s target of an annual rate below but close” to 2 per cent and is likely to turn negative in coming months.

But Jean-Claude Trichet, ECB president, has previously voiced the widespread concern among ECB governing council members that zero interest rates create damaging economic distortions.

Mr Trichet will explain the ECB’s decision at a press conference on Thursday afternoon, when financial markets will be listening for announcements on additional measures to boost the eurozone economy. So far, the ECB’s efforts have focused on enhanced credit support,” which has seen it providing banks with unlimited amounts of liquidity. One option would be to extend the period over which such liquidity is provided from the current maximum of six months.

Another possibility, hinted at last week by Lucas Papademos, the ECB’s vice-president, would be to move closer to the outright purchase of corporate debt. Such a step, which would involve circumventing the banking system, would take the ECB into new territory.

Since the ECB’s March meeting, eurozone economic data has continued to deteriorate with scant signs of stabilisation on the horizon. Germany’s export-dependent economy has been particularly badly hit – and is widely expected to fare worse this year than either the UK or US, even though its financial system has proved less fragile. Earlier this week the Paris-based Organisation for Economic Cooperation and Development forecast the German economy would contract by 5.3 per cent in 2009. Eurozone gross domestic product was expected to fall by 4.1 per cent.

ECB Cuts Rates to 1.25%