ECB stimulus package could extend to €500bn over 3 years

The European Central Bank has cut headline interest rates to a new record low of 0.05 per cent in a surprise move this lunchtime.

The move was accompanied by an announcement by the bank that it is to embark on a new plan to buy asset-backed securities and covered bonds, in a bid to kickstart the ailing euro zone economy.

Sources said the programme could amount to €500 billion over three years but this was not confirmed.

While the announcement of an asset-backed security purchase programme had been expected, the decision to cut interest rates from 0.15 per cent to 0.05 per cent took markets by surprise, sending the euro sharply lower.

Speaking in Frankfurt, ECB chief Mario Draghi said the plan to buy asset-backed securities and covered bonds from euro zone banks would have a “sizeable impact” on the bank’s balance sheet.

Asset-backed securities are created by banks pooling mortgages and corporate, auto or credit card loans and selling them to insurers, pension funds or now even the ECB. Covered bonds are similar instruments but the underlying assets are ringfenced so if the bank goes bust, the assets are still there.

The programme aims to encourage more lending in the economy by taking loans of the balance sheets of euro zone banks.

The move was widely expected today following Mr Draghi’s suggestion at a gathering of world bankers in Jackson Hole two weeks ago that the ECB was ready to “adjust our policy stance further” and “use all available instruments needed to ensure price stability.”

But the bank stopped short of engaging in full-scale quantitative easing which would involve the purchase of sovereign debt.

Unlike the US, Britain and Japan the ECB has not engaged in quantitative easing since the onset of the financial crisis, a decision that has been criticised by some analysts.

Under the programme announced today, the ECB will buy both asset-backed securities – mortgage and other loans that are bundled together and sold on – and covered bonds, widely seen as a safer class of assets.

“The Governing Council sees the risks surrounding the economic outlook for the euro area on the downside,” Mr Draghi told a news conference. “In particular, the loss in economic momentum may dampen private investment, and heightened geopolitical risks could have a further negative impact on business and consumer confidence.”

New ECB economic forecasts predicted slower growth this year - of just 0.9 percent - picking up to 1.6 per cent in 2015. The forecast for inflation, now running at just 0.3 per cent, was cut to 0.6 per cent, rising to 1.1 per cent in 2015, still way below the ECB’s target of close to but below 2 per cent.

Mr Draghi said if inflation looked like staying too low for too long, the ECB Governing Council was unanimous in its commitment to using other “unconventional instruments” - a phrase taken as code for printing money as the US Federal Reserve and Bank of England have. He added that today’s decisions were not supported unanimously by his colleagues although there was a “comfortable majority”.

Mr Draghi said more detail would be provided later this year, with the programme due to commence next month.

Mr Draghi’s problem is that the ECB is running out of ammunition with which to fight such low inflation. The one big weapon it retains is quantitative easing (QE) - essentially printing money to buy assets.

Though other central banks have used this tool, hawkish members of the ECB’s 24-member policymaking council are resistant.

. As well as hinting at further ECB policy action, Mr Draghi used his Jackson Hole speech to urge governments to use fiscal policy and structural reforms to support the euro zone economy.

Many observers focused on Mr Draghi’s comment that there was scope for governments to use fiscal policies to help growth as the main message of the speech, but some - particularly in Germany - said his remarks had been misread.

Additional reporting by Reuters