ECB cuts rates further below zero

The central bank unveiled a new bond-buying programme at its meeting Thursday

Mario Draghi, president of the European Central Bank (ECB), speaks during a rates decision news conference in Frankfurt, Germany, on Thursday. Photo: Bloomberg
Mario Draghi, president of the European Central Bank (ECB), speaks during a rates decision news conference in Frankfurt, Germany, on Thursday. Photo: Bloomberg

The European Central Bank cut interest rates further below zero and will start open-ended bond purchases after President Mario Draghi overcame critics of his stimulus policies to make a final run at reflating the euro-area economy.

The Governing Council reduced the deposit rate to minus 0.5 per cent from minus 0.4 per cent, and will buy debt at 20 billion euros (Dh80bn) a month starting November 1. Banks will get exemptions from the negative rate for some of their deposits after an outcry from lenders about the squeeze on profitability.

European government bonds rallied on the announcement, led by a surge in Italian securities that sent 10-year yields to a record low, and credit spreads tightened. The dovish policy shift weighed on the euro, which weakened against its major counterparts, while the Stoxx Europe 600 Index rose to its highest level since July.

The ECB also changed its guidance on interest rates to say they will stay at present or lower levels until the outlook for inflation “robustly” converges to its goal of just below 2 per cent. It previously expected borrowing costs to stay unchanged until mid-2020. It also scrapped a 10-basis point rate premium previously attached to its long-term loan program.

US President Donald Trump tweeted that the ECB is “acting quickly” while the Federal Reserve “sits, and sits, and sits.” He has previously cited loose ECB policy in his calls for the Federal Reserve to cut rates steeply.

The Fed is likely to lower borrowing costs next week for the second time this year, as central banks around the world ease to combat the spreading weakness.

The ECB’s announcement of a new stimulus package is a remarkable turn of events, just nine months after it signaled it was done with ever-looser policy. Now inflation is running at barely half the goal, and the manufacturing sector is in a contraction that risks spreading to the rest of the economy.

Hours before the decision, industrial-production figures showed the third quarter off to a weak start with euro-zone output dropping 0.4 per cent in July, more than expected. The decline was led by Germany, which is on the verge of a recession as a global slowdown in trade caused by the US-China standoff and the uncertainties surrounding Brexit hurts its exporters.

The approval of such broad measures is a win for Mr Draghi in his penultimate meeting before he steps down next month. Governors from core economies including Germany and the Netherlands pushed back against the resumption of quantitative easing, saying it should be a last resort in case the outlook worsens.

Still, there are doubts the ECB’s latest measures will prove as effective as hoped. Longer-term bond yields have already fallen sharply because of the economic slowdown, and another round of debt purchases might not exert much more downward pressure.

Academics have questioned the effectiveness of negative rates, with a recent study published by the University of Bath finding they decreased lending. The fact that the latest rate cut is accompanied by exemptions to soften the impact on banks will fuel those concerns. Lenders say they are forced to absorb most of the cost of negative rates, a charge on their overnight deposits at the central bank, because they can’t easily be passed onto ordinary customers.

Such doubts over the remaining firepower of central banks have put the spotlight on fiscal stimulus. Mr Draghi and his successor, Christine Lagarde, have both repeatedly called on governments to do more to bolster the economy.

Published: September 12, 2019 05:15 PM


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