ECB cuts rates to combat recession

By Ralph Atkins in Frankfurt and and Chris Giles and David Oakley in London

Published: May 7 2009 12:46 | Last updated: May 7 2009 21:10

European central banks on Thursday intensified their efforts to combat the continent’s severe recession by unveiling bolder-than-expected moves to buy assets and boost growth through historically-low interest rates.

The European Central Bank cut its main interest rate by a quarter percentage point to 1 per cent, the lowest yet, and announced plans to buy €60bn of covered bonds, which are backed by mortgage or public sector loans.
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Separately, the Bank of England said it would pump a further £50bn (€56bn) into the UK economy through its programme of “quantitative easing”.

Signalling significantly greater flexibility, Jean-Claude Trichet, ECB president, said official eurozone borrowing costs could fall again.

Several ECB governing council members had previously publicly opposed cutting rates below 1 per cent, and Mr Trichet had warned of the dangers of letting rates fall to zero.

ECB policymakers also stressed the importance of a decision to extend its emergency provision of liquidity so banks could borrow unlimited amounts for 12 months – up from the current six months maximum.

The announcements reflected increased ECB gloom over the economic outlook for the 16-country eurozone, which is expected to be hit worse this year by the global slowdown than the US or UK.

Mr Trichet warned that the first quarter had been “very bad” in the eurozone, although there had been “tentative signs” of stabilisation. ECB growth forecasts would be revised down next month, he said

Mr Trichet insisted, however, that the ECB was “not embarking” on quantitative easing – the creation of money to buy assets – with its covered bond purchases. The ECB expects the liquidity it injects into the financial system by buying covered bonds to result in eurozone banks demanding less from the ECB’s financing operations – avoiding inflationary consequences.

However, he was careful not to rule out any policy options – and analysts said Thursday’s relatively modest move pointed to a reduced resistance towards following the US Federal Reserve and Bank of England in embracing “non-conventional” policies. The ECB had showed it was “ready to take all actions needed”, argued Marco Annunziata, chief economist at UniCredit in Milan.

The ECB announced it would also give the European Investment Bank access to its liquidity, which could enable the EIB to boost help for companies, including in eastern Europe.

The Bank of England’s latest action was in response to what it described as a “substantial margin of spare capacity in the economy”.

It has already purchased a little over £50bn of UK government bonds in its programme of quantitative easing and will reach its initial target of £75bn, some 5 per cent of national income, by the end of the month.

The UK monetary policy committee said the stimulus for the country’s economy “should in due course lead to a recovery in economic growth, bringing inflation back to the 2 per cent target. But the timing and strength of that recovery is highly uncertain”.

The euro rose 1.4 per cent against sterling at £0.8924 as traders viewed the bolder plans by the Bank of England as creating more inflationary pressures than the ECB’s more cautious moves.