News Column

ECB Cuts Rates Amid Deflation Fears

November 7, 2013

Financial Mirror (Cyprus)

euro drowning
The euro fell as the European Central Bank cut interest rates to new lows (file photo)

The European Central Bank cut interest rates to a new record low on Thursday, responding to a slump in inflation way below its target that has sparked fears the euro zone's economic recovery could stall.

The news sent the euro falling 1% against the dollar to a seven-week low of $1.3356 while European shares and German Bunds rose.

Bund futures rose as high as 141.88 after the decision, up 73 ticks on the day. Euro zone bond yields fell broadly after earlier trading mostly flat.

The Euro STOXX 50 index of euro zone blue chips hit a five-year high and was up 0.9% at 3,083.40 points. The pan-European FTSEurofirst 300 index was also at a five-year high, up 1.1%.

The 23-man Governing Council had faced intense market scrutiny in the run-up to Thursday's decision after a shock slump in euro zone inflation to 0.7% in October - far below the ECB target of just under 2%.

Calls from government ministers and industry - the loudest from Italy - for the ECB to loosen policy to help bring down the euro's exchange rate had also heaped pressure on the Council, though few analysts expected a move this month.

The ECB cut its main refinancing rate to 0.25%. It held the deposit rate it pays on bank deposits at 0.0% and cut its marginal lending facility - or emergency borrowing rate - to 0.75% from 1.00%.

"The ECB knows that a rate cut at the current juncture will do only very little to kick start the economy or to fight deflation," said ING economist Carsten Brzeski. "In my view, it's aimed at further weakening of the euro exchange rate." Attention now shifts to ECB President Mario Draghi's news conference.

Markets will be listening for any indication of whether the cut marks the end of the ECB's policy easing cycle and what it means for the ECB's forward guidance on interest rates.

Since July, the ECB has said it expects to keep its key rates "at present or lower levels" for an extended period.

Markets will also be alert to any signals that the ECB could offer banks another injection of liquidity with long-term loans, known as LTROs.

Adding to the ECB's dilemma over how to support a fragile recovery is a fall in excess liquidity - cash beyond what lenders need to cover day-to-day operations - as banks repay 3-year ECB loans early before a health check next year.

These early repayments are expected to push interbank lending rates higher over time and the ECB has been considering pumping more liquidity into the system to offset this development.

The cut in the main refinancing rate to 0.25% could potentially also slow the pace of long-term refinancing operation (LTRO) repayments, as lower interest costs make it more attractive for banks to hold on to the loans for longer and invest them in higher-yielding assets.

Draghi will use his news conference to try to dispel concerns that October's inflation drop raises the spectre of deflation in the euro zone.

The head of Italy's business lobby Confindustria said on Wednesday the country was in a worrying "situation of deflation".

(c) 2013 Financial Mirror. All right reserved. Provided by an company

Original headline: ECB cuts rates to new low, Euro falls, shares rise

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Source: (c) 2013 Financial Mirror. All right reserved. Provided by an company

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