ECB chief says rate cut has nothing to do with Greek crisis

Fri, Nov 4, 2011, 00:00

EUROPEAN CENTRAL Bank president Mario Draghi has said yesterday’s 25 basis-point interest rate cut was in answer to the euro zone’s deteriorating economic outlook and had “nothing in common” with the ongoing Greek crisis.

Yesterday’s unanimous vote by the ECB governing council to reduce its key interest rate to 1.25 per cent surprised many analysts. Given the ongoing euro zone drama, few expected a change in Mr Draghi’s first outing as head of the bank’s governing council.

But the Italian economist hit the ground running by announcing the bank’s first rate cut since May 2009, citing falling inflationary pressure and a “mild recession” heading the euro zone’s way in the final months of this year.

“The economic outlook continues to be subject to particularly high uncertainty and intensified downside risks,” said Mr Draghi.

The move lifted euro zone shares yesterday.

The ECB president said his bank was confident that inflation, although high at present, would begin to fall in 2012 as a natural effect of economic pressures visible in financial data and, in the long term, was firmly anchored at 2 per cent.

“We concluded that there was a weakening of the business cycle and there is a likelihood I may have to revise downward the projections we will be presenting next month,” said Mr Draghi.

“The weakening of the business cycle will by itself have dampening effects on wages, prices and costs and will itself have a dampening effect on inflation.”

The new ECB president said a clear pattern of deterioration was discernible in economic data, particularly in the manufacturing sector, and that there was a further high economic risk arising from the knock-on effects of euro-zone austerity measures.

In its communique, the ECB governing council urged euro zone members to implement in full last week’s summit proposals and to implement “urgently” comprehensive structural reforms.

“The government of countries under joint EU-IMF adjustment programmes and those of countries that are particularly vulnerable should stand ready to take any additional measures that become necessary,” the council said in its statement.

Mr Draghi said the “exceptional and unique” nature of the Greek crisis meant Ireland could not expect a similar discount on its debt. “We are confident that the Irish Government could comply with the measures announced and the Irish Government announced it will do whatever it takes,” he said. “One has no reason to doubt about the commitment of the Irish Government.”

Mr Draghi said the council was in agreement that sound bank balance sheets were key to preventing a “negative feedback loop” in the financial sector. He said the ECB welcomed last week’s summit proposals to increase bank capital to 9 per cent of core Tier 1 by the end of next June.

Pressed on record spreads among euro zone sovereign bonds, he said markets, after “undershooting for a long period of time, may now be overshooting”.

“For a long time spreads in the euro area were very thin. They were not reflecting the different realities of the different countries,” he said.

The financial crisis had made investors more risk-averse and sensitive to the differences in euro-zone members’ situations.

“The way to react to this is not to count on external help that could alleviate the temporary market pressure but to count on the countries’ capacity to reform with right economic policies.”

After being wrong-footed yesterday, many analysts suspended judgment on Mr Draghi’s debut.

“The interest-rate cut looks positive at first,” said Markus Huber, a trader at ETX capital.

“But the more important question is whether the market views this as a cool-headed decision or a sign of larger problems.”