ECB cuts interest rate, extends purchases to boost inflation

European Central Bank announces that it is cutting key interest rate, extending its monthly asset purchases in attempt to boost inflation

Photo by: Reuters
Photo by: Reuters

View of the exterior of the European Central Bank (ECB) headquarters in Frankfurt, Germany on December 3, 2015

The European Central Bank stepped up efforts Thursday to kickstart chronically low inflation in the euro area, cutting a key interest rate and extending its controversial asset purchase programme, but financial markets reacted with disappointment.

At the ECB's last monetary policy meeting of the year, the governing council decided that the key deposit rate would be lowered to minus 0.30 percent.

The deposit rate is normally the interest banks would receive from parking cash overnight at the ECB. But it has been negative since June 2014, meaning banks effectively have to pay the ECB to hold their funds.

The idea is to persuade banks to lend the money to businesses and households rather than store it at the ECB.

At the same time, the ECB held its other two key rates -- the refi and marginal lending rates -- unchanged at 0.05 percent and 0.30 percent respectively.

At his traditional post-meeting news conference, president Mario Draghi announced that the bank would also beef up its controversial bond purchase programme, known as QE.

QE stands for quantitative easing and is a scheme under which the central bank planned to buy up 1.14 trillion euros of bonds at a rate of 60 billion euros per month, at least until September 2016.

The aim, alongside lower interest rates and unprecedented amounts of cheap loans made available to banks, was to restart lending and push eurozone inflation back up to levels conducive to healthy economic growth.

But inflation across the eurozone is still doggedly low, standing at just 0.1 percent in November, far below the ECB's target of just under 2.0 percent.

QE extended

In a bid to correct this, the ECB decided to extend the purchases to March 2017 and possibly beyond and to widen the net to include other categories of bonds, Draghi said.

Draghi insisted that the measures were working and that was why the ECB had decided to step up the QE programme.

The ECB was "doing more because it works, not because it fails," he said.

At the same time, "we had to recalibrate our measures due to changing circumstances over the summer," Draghi admitted, insisting that the ECB was ready to do it again if the "external conditions put at risk achievement of our objective."

Nevertheless, financial markets appeared to have expected an even more generous Christmas bonanza, with stock markets nosediving and the euro rising as analysts complained the bank should have done more to rekindle eurozone growth.

In afternoon trade, Frankfurt's DAX 30 plunged 3.57 percent, London's FTSE 100 index lost 1.06 percent, and the CAC 40 in Paris dropped 1.89 percent.

The euro meanwhile recovered from close to an eight-month low, jumping to nearly $1.09 before settling at $1.08 after having struck $1.0551 on Wednesday -- which was the lowest level since mid-April.

"Santa Mario did not turn into the Grinch, the Christmas monster. However, (he) left many market participants disappointed like small kids who receive less and smaller presents than expected on Christmas eve," said ING DiBa economist Carsten Brzeski.

"For the first time in a long while, Draghi underachieved and delivered less than the market consensus had expected. As a result, the euro appreciated and bond yields increased immediately after the policy decision."

Rate cut disappoints

Jonathan Loynes at Capital Economics also said the ECB had "failed to live up to its own hype."

The reduction in the deposit rate was "disappointingly small," he said. And the ECB had failed to make up for that with a "decisive" expansion of its asset purchase programme, which had been "merely extended ... from September 2016 to March 2017."

"Of course, it's possible that the slightly better news on the economy over recent weeks persuaded the governing council that more aggressive action was not necessary. And Draghi has left the door open to further policy loosening in the future," Loynes conceded.

"Nonetheless, together with the rate cut, this will be seen as a clear disappointment in the light of the repeated extremely dovish signals from the president and his colleagues," he said.

The ECB also published its latest updated economic projections, downgrading its forecasts for inflation in 2016 and 2017, but fractionally raising its growth forecasts for this year and 2017.