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European Central Bank Surprises With Rate Cuts, New Stimulus Plan
Thursday, 04 Sep 2014 09:56 AM
Trying to salvage a weak recovery, the European Central Bank on Thursday cut interest rates and announced a new economic stimulus program that involves buying financial assets.
The chief monetary authority for the 18 countries that use the euro cut its benchmark interest rate from 0.15 to 0.05 percent, a new record low. The step reduces the costs banks pay when they borrow from the ECB. Lower rates stimulate more lending and growth.
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But companies are finding credit hard to get even with low rates. So the ECB turned to more drastic measures and also announced a program to buy private-sector bonds.
The aim is to make credit cheaper and easier to get, helping investment and growth at a time when the economy of the 18-country eurozone has stalled. The economy did not grow at all in the second quarter, raising fears of a triple-dip recession.
President Mario Draghi said the ECB would buy so-called asset-backed securities. They are bonds that can be put together from a wide range of loans made by banks, such as mortgages or loans to companies.
By buying asset-backed securities, the ECB gives banks an incentive to issue more of the loans that are used to build them. And since the ECB uses newly-created money to buy them, it pumps cash into the financial system, expanding the amount of money available to lend.
Some investors had been expecting the ECB to say it was preparing a new stimulus program, but most did not expect an announcement as early as this week.
"This surprising move does showcase how eager the ECB are to encourage banks to lend again," said Jameel Ahmad, chief market analyst for FXTM.
The new program is somewhat different from the stimulus program that the Federal Reserve has undertaken with some success — large-scale purchases of government bonds. Purchasing government bonds has the advantage that there are more of them to buy — meaning a potentially larger stimulus. But it would open the ECB to charges it was using its policies to help governments that need to take action themselves to improve growth and fix their finances.
The ECB's largely unexpected actions moved markets. The euro fell to $1.2995, its first time below $1.30 since July 2013.
The ECB also cut its deposit rate — what banks pay to keep their money at the central bank — to minus 0.2 percent from minus 0.1 percent. The negative rate is an effort to push banks to lend money by imposing a financial penalty for hoarding it in the safety of the ECB's accounts.
The measures announced Thursday will come on top of a raft of steps announced in June. Back then, the ECB cut rates and said it would offer more cheap loans to banks on condition they lend the money on to companies. The first of those loans will be handed out on Sept. 18.
Draghi said there were differences of opinion among the ECB's governing council on whether to approve the new stimulus program or how to set it up.
"Some of our council members were in favor of doing more, and some were in favor of doing less," he said.
Besides asset-backed securities, the ECB program includes covered bonds. Covered bonds are asset-backed securities with additional rights for lenders.
To reflect the darkening of the outlook for the eurozone economy, the ECB cut its economic growth forecast for 2014 to 0.9 percent from 1.0 percent previously. It lowered its inflation forecast to 0.6 percent from 0.7 percent.
Draghi said that despite the new measures, the ECB cannot save the economy by itself. He said government need to enact longer-term, structural reforms such a reducing the regulations governing hiring and firing employees. He has made the call repeatedly, but progress has been slow in countries such as France and Italy.
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"You need growth. You need employment. You need structural reforms, first and foremost" he said.
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