The European Central Bank (ECB) has cut its benchmark interest rate to a record low of 0.25%.
ECB president Mario Draghi (pictured) said the 25 basis points cut reflected an outlook of low inflation and economic weakness in the eurozone. Inflation fell to 0.7% in October – its lowest level since January 2010, stoking concerns of deflation in some countries.
The decision was in line with the forward guidance that the ECB gave in July 2013, but still came as a surprise to many economists. According to Draghi the cut is a result of diminishing pressure on prices over the past few months. Although Draghi admitted that Europe may experience a prolonged period of low inflation, he complemented that statement by highlighting that the ECB’s long-term forecasts show that this period will be followed by a gradual increase in prices toward the inflation target of 2%.
The ECB also decided to continue its main refinancing operations at a fixed rate with full allotment for as long as necessary, and at least until 7 July 2015. This essentially means that banks will be able to borrow as much money as they want from the ECB at a fixed rate for the foreseeable future.
JP Morgan Asset Management global market strategist David Lebovitz, said although Draghi did not explicitly address the recent strength of the euro, it seems logical that today’s decision to ease may have in part been an effort to weaken the common currency. With rates so close to zero, the ECB may be attempting to stimulate growth and fight deflation via a weaker euro. The currency fell over 1% relative to the US dollar when the rate cut was announced.
He added: “Today’s rate cut is positive in the sense that it highlights the ECB’s commitment to firmer inflation expectations given its single mandate for price stability. Eurozone inflation has fallen from an annual rate of 1.6% in June this year to a meagre 0.7% in October, and although Draghi noted during his press conference that he does not see deflation risk, he did note that prices could fall further and that he expects inflation to remain low for the foreseeable future.
“Today’s decision begs the question of how the ECB will react if stronger growth and inflation fail to materialise, and whether a negative deposit rate, active use of outright monetary transactions (OMT), or other unconventional measures may be employed in the not too distant future.”
Aberdeen Asset Management investment analyst Luke Bartholomew said with inflation falling and the euro appreciating significantly recently, the rate cut made economic sense.
“It is only a surprise to the market because the ECB has been so slow to react in the past,” he added. “But Draghi knows that the spectre of deflation is stalking the eurozone and wants to be seen to be taking action. The rate cut is a strong signal that the ECB will do everything it can to fight deflation and take the action that economic recovery requires.”
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