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ECB cuts interest rate and expands stimulus

Published 03/12/2015

The bank is reducing the interest rate on deposits from commercial banks
The bank is reducing the interest rate on deposits from commercial banks

The European Central Bank has cut a key interest rate and extended its stimulus programme to bolster the 19-country eurozone economy - but the actions underwhelmed investors, who pushed stocks sharply lower.

The main move by the ECB was to cut the interest rate on deposits from commercial banks from -0.2% to -0.3%.

That is intended to push banks to lend by imposing a penalty on the cash they park at the central bank. Many in the markets, however, had predicted a bigger cut to -0.4%.

And alongside other measures, ECB president Mario Draghi said the bank will extend the duration of its bond-buying programme, which aims to make borrowing cheap in the wider economy.

Mr Draghi said the programme, which was due to run at least through September 2016, is now intended to run until March 2017 or beyond if necessary. Though the program has been extended, which will increase the size of the overall stimulus from the previous 1.1 trillion euros (£780 billion), the monthly cap of 60 billion euros (£42 billion) in purchases was maintained.

"Today's decisions were taken in order to secure a return of inflation rates towards levels that are below, but close to, 2% and thereby to anchor medium-term inflation expectations," Mr Draghi told reporters at a news conference.

The ECB, the chief monetary authority for the countries that use the shared euro currency, also:

:: Expanded the kinds of bonds it would buy, to include those issued by regional authorities.

:: Said it would re-invest principal payments on the bonds it has bought. This is an important step that means the eventual maturing of the bonds will not reduce the level of monetary stimulus over coming months and years.

:: Extended its offer of unlimited short-term credits to banks through the end of 2017.

The actions were not enough however to satisfy markets, which expected significantly more.

"This has been a huge failure from the ECB," said James Hughes, chief market analyst at GKFX. "Much more was expected."

Mr Draghi said the decisions were not unanimous but that there was a very large majority in favour of the moves. He said the deposit rate cut was "adequate."

"I don't think our communication was wrong," he said. "I think these measures need time to be fully appreciated."

The ECB wants to raise annual inflation toward its goal of just under 2% as part of its legal mandate to maintain price stability.

Mr Draghi said there are "continued downside risks" to the inflation outlook. The ECB trimmed its forecasts for inflation next year, to 1% from 1.1% previously, and for 2017 to 1.6% from 1.7%.

"The persistence of low inflation rates reflects sizeable economic slack weighing on domestic price pressures and headwinds from the external environment," he said.

Low inflation can help consumers by making their euros go farther. But it is a sign of weak demand, and can lead to chronic stagnation if people begin anticipating flat or falling prices in purchasing decisions and wage agreements.

Weak inflation of the sort prevalent in the eurozone makes it harder for the currency union's indebted members such as Greece to reduce their burdens and to bring their business costs down relative to their eurozone trade partners - a necessary step in their economy recovery.

The eurozone economy as a whole grew by a moderate 0.3% in the third quarter, while unemployment is falling but only gradually from high levels.

Draghi said the economic recovery should proceed but that it "continues to be dampened by subdued growth prospects in emerging markets and moderate global trade, the necessary balance sheet adjustments in a number of sectors and the sluggish pace of implementation of structural reforms."

The ECB's current policy path contrasts with that of the US Federal Reserve, which has ended its own bond purchase program and is expected to start raising interest rates from near zero at its next meeting on December 16.

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