European Central Bank cuts rates to new low

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Associated Press

Posted on July 5, 2012 at 1:01 PM

Updated Thursday, Jul 5 at 5:05 PM

FRANKFURT, Germany (AP) — The European Central Bank cut its benchmark interest rate to a record low Thursday to spark economic growth but gave little sign it would take further action soon to ease Europe's financial crisis.

By cutting its key refinancing rate by a quarter percentage point to 0.75, a move that was widely expected, the ECB sought to give Europe's sagging economy a lift by making it cheaper for businesses and consumers to borrow.

Financial markets were underwhelmed, though, and even ECB President Mario Draghi conceded during a press conference that the impact of the rate cut could be "muted" given the low demand for credit in the slow economy. Analysts noted that interest rates were already low, that banks remain wary of lending to each other and that businesses and consumers see little reason to take on more debt.

In a more surprising move, the ECB also cut the interest rate it pays banks on overnight deposits by a quarter percentage point — to zero. The move could nudge banks to lend more money, rather than sock it away with the ECB and earn no interest. But even that move could have limited effect, analysts said, since there are other safe havens for banks to park their money.

Draghi said the bank acted in the face of economic pressures being felt by the 17 countries that use the euro, nearly half of which are in recession.

He said there is more the ECB could do to stimulate growth — "we still have all our artillery ready" — and indicated inflation should remain low, which gave the bank room to reduce rates.

But Draghi, who has said Europe's problems cannot be solved without stronger political and economic ties, offered little hope the bank would take more emergency measures to ease the debt crisis, such as cheap loans for banks. He did, however, indicate the ECB could make it easier for banks to borrow from it by accepting a wider range of collateral.

Stock markets initially rose after the ECB's rate announcement, but fell back down as investors worried about a slowdown in the global economy. Germany's DAX stock index closed 0.5 percent lower while the Dow fell 0.1 percent. The euro was down 1.1 percent at $1.2380.

"Today's ECB interest rate cut does little to alter the bleak economic outlook," said Jennifer McKeown, analyst at Capital Economics. She said the ECB is likely to now wait and see how the financial markets and the economy react to the emergency measures announced by European leaders last week.

The leaders agreed to make it easier for troubled countries and banks to receive rescue loans from Europe's bailout fund and also signaled greater willingness to use emergency funds to purchase government bonds. The goal would be to drive down troubled countries' borrowing costs. They also agreed to create a single Europe-wide banking regulator to prevent bank bailouts from wrecking individual countries' government finances.

Collectively, the moves sent a message to financial markets that eurozone leaders could work together to fix their problems. Draghi welcomed the measured, though they will take some time to put in place. The markets also cheered the measures, pushing down the high borrowing costs for financially stressed countries such as Italy and Spain, the euro region's third- and fourth-largest economies.

But fears remain high that a bankrupt Greece could eventually leave the euro, or that Spain or Italy could need bailouts that would strain the resources of other countries in the euro.

Joerg Kraemer, chief economist at Commerzbank, said the latest ECB action wouldn't fix what was wrong. The reason the eurozone economy is weak is not because of "high ECB rates but because of uncertainty stemming from the sovereign debt crisis. This can't be cured by lower rates."

Cutting the ECB's refinancing rate to 0.75 percent will give some further relief to banks by lowering the amount they pay on €1 trillion in cheap, three-year emergency loans they took from the ECB on Dec. 21 and Feb. 29. The cost of that money is the average refinancing rate over the life of the loans.

The quarter percentage point cut in the deposit rate is meant to push banks to stop using the ECB as a safe haven by parking money there overnight. Before the debt crisis exploded, banks would typically deposit less than €100 billion with the ECB overnight, often much less. On Wednesday, banks had placed €790 billion with the ECB overnight.

A central bank is an ultra-safe place for banks to deposit their money, but there are other havens such as the government bonds of financially strong countries like Germany.

The eurozone crisis has battered investor confidence for 2 ½ years. It has seen Greece, Ireland, Portugal and Cyprus need bailouts from the other eurozone countries and the International Monetary Fund to keep paying their debts and covering their budget deficits. Spain has asked for as much as €100 billion in rescue loans for its banks. Cyprus is still negotiating its own bailout, which is expected to be used to help both its banks and the government.

Earlier in the day, the central banks of China and Britain took action to stimulate their economies.

The Bank of England decided to purchase another 50 billion pounds in government bonds from financial institutions. The hope is that the banks will use the extra cash to lend to businesses and households.

China's central bank, meanwhile, cut interest rates for the second time in a month to shore up its economy, the second-largest in the world. Interest on a one-year loan was reduced by 0.31 percentage points to 6 percent effective Friday. Chinese authorities have rolled out a series of stimulus measures since March after economic growth slowed to a nearly three-year low of 8.1 percent in the first quarter.

In the U.S., weak economic indicators have raised speculation that the U.S. Federal Reserve may also have to do more to keep the U.S. economy growing. Some think the Fed might carry out a third round of bond purchases aimed at driving down interest rates on business and consumer loans.

The Fed took more limited action at its meeting ending June 17, extending its so-called Operation Twist effort in which it sells short-term bonds and buys longer-dated issues to push down long term interest rates. The Fed meets next Aug. 1.

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