ECB rate cut ‘a sign of the gravity of the situation’
The bank also signalled its intent to provide cheap liquidity until 2015
The European Central Bank’s reputation as one of the more conservative of the world’s central banks was overturned yesterday by the surprise decision to cut interest rates.
The rebound in the euro ahead of the rate-setting meeting had been a strong indication that markets did not expect a cut. Virtually all analysts were predicting that, at the very most, ECB president Mario Draghi would signal a future move, with most expecting a rate announcement in December.
The stark divergence between the view of the market and the ECB’s course of action tells its own story.
Draghi has garnered a reputation for favouring words over action. The ECB’s most powerful monetary instrument, OMT (Outright Monetary Transactions where the ECB can buy member states’ bonds in the secondary markets) has taken on near -mythical status: it has never been used, prompting some critics to ask facetiously if it really exists. To the ECB’s credit, the threat of action has been sufficient to keep markets under control over the last year or so. Most famously, Draghi’s pledge last year to do “whatever it takes” to preserve the euro is widely credited with calming markets over the last 18 months.
The fact that the ECB chose to act so decisively (and in such an uncharacteristic manner) indicates the seriousness of the situation facing the euro zone.
As well as a cut to the benchmark interest rate and refinancing rate, the bank also committed to providing cheap liquidity to banks until July 2015. On cue, the euro slid dramatically while government bond yields soared.
Draghi gave some insight into the thinking behind the rate cut. The 23-member governing council was “wholly in agreement about to act, but there were differences about when to act”, he said at the press conference, with some members favouring holding off until next month. A “significant majority” thought there was “enough evidence” to act, however, a sign of the gravity of the situation.
Alarming inflation trend
A swathe of economic indicators in the last month has painted a worrying picture of the health of the euro zone economy, despite the bloc technically emerging from recession earlier this year.
Of most significance is undoubtedly the inflation trend. While the inflation rate has been gradually dropping month on month, the slide to 0.7 per cent in October – well below the ECB’s target level of 2 per cent – was alarming. Virtually all euro zone countries, including behemoths like Germany, are experiencing low inflation. In countries like Greece, deflation is already in place, while Spain is also moving perilously close to deflation.
With the maintenance of price stability the bank’s primary objective, action was logical. But analysts welcomed the first indication that the ECB is prepared to tackle deflationary as well as inflationary risks.
While Draghi repeated his often-repeated mantra that exchange rates are not a target for the ECB, and did not feature in the discussion of the interest rate cut, the strength of the euro has been a concern in recent months. Estimates put the euro’s appreciation at any where between 3 and 5 per cent in real terms so far this year, something that is hurting some of the region’s peripheral economies in particular.