By Eva Taylor and Paul Carrel
The European Central Bank cut interest rates to a fresh record low on Thursday and launched a new scheme to push money into the flagging euro zone economy.
In a series of measures underscoring growing concern about the currency bloc’s health, the ECB cut its main refinancing rate to 0.05 per cent from 0.15 per cent previously and drove the overnight deposit rate deeper into negative territory, now charging banks 0.20 per cent to park funds with it.
The euro zone flatlined in the second quarter of the year and the Ukraine crisis is now weighing heavily on business confidence.
“The Governing Council sees the risks surrounding the economic outlook for the euro area on the downside,” ECB President Mario Draghi told a news conference.
“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.”
New ECB economic forecasts predicted slower growth this year, of just 0.9 per cent, picking up to 1.6 per cent in 2015.
The forecast for inflation, now running at just 0.3 per cent, was cut to 0.6 per cent, rising to 1.1 per cent in 2015, still way below the ECB’s target of close to but below 2.0 per cent.
Draghi said if inflation looked like staying too low for too long, the ECB Governing Council was unanimous in its commitment to using other “unconventional instruments” – a phrase taken as code for printing money as the US Federal Reserve and Bank of England have.
He added that Thursday’s decisions were not supported unanimously by his colleagues although there was a “comfortable majority”.
Draghi also announced plans for an asset-backed securities (ABS) and covered bond purchase programme to help ease credit conditions in the bloc. Sources told Reuters it could amount to 500 billion euros ($650 billion) over three years.
Asset-backed securities are created by banks pooling mortgages and corporate, auto or credit card loans and selling them to insurers, pension funds or now even the ECB.
Covered bonds are similar instruments but the underlying assets are ringfenced so if the bank goes bust, the assets are still there. That makes them safer than ABS where the underlying loans are not ringfenced.
“At the margin, (the cuts) may have some small positive effect on bank lending and activity and perhaps give the euro another downward nudge,” said Jonathan Loynes, chief European economist at Capital Economics.
“But these moves are no substitute for the much more powerful policy action which looks increasingly necessary to prevent a renewed recession.”
QE OR NOT QE
For investors and markets, the only gambit that will make a big difference is a large-scale US-style asset purchase, or quantitative easing, programme that buys government debt with new money.
Draghi ramped up expectations when, departing from the text of a speech, he told the Jackson Hole central bankers’ conference on Aug. 22 that markets had indicated inflation expectations showed “significant declines” in August.
Then, he said the ECB’s Governing Council would, within its mandate, “use all the available instruments” to deliver price stability over the medium term.
Though other central banks have printed money in vast amounts, some 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”.
What is more, the ECB will want to see the impact of a four-year loan offer to banks, announced in June but only launching later this month, before taking the ultimate step.
The interest rate cut will make the upcoming loan offer, or TLTRO, more attractive as banks can now get the funds for less. But with lending still impaired, the wider impact is uncertain.
Draghi also expanded on his call in Jackson Hole for governments to use fiscal policy – more government spending – and economic reforms to support the euro zone economy.
He said euro zone countries should use existing flexibility within its debt rules, rather than break them, in order to help pursue structural economic reforms.
“There is also leeway to achieve a more growth-friendly composition of fiscal policies,” he said.