Economic analysis

European Central Bank startles investors

FRANKFURT – The European Central Bank has startled investors with a surprise cut in its benchmark interest rate aimed at boosting a hesitant recovery in the 17 countries that use the euro.

The bank lowered the benchmark refinancing rate to a record low 0.25 per cent from 0.5 per cent at a meeting of its 23-member governing council in Frankfurt, causing stock markets to rally and the euro to slump.

Recent economic data, such as unexpectedly low inflation of 0.7 per cent, showed the eurozone’s economic recovery remains weak. But most economists thought the bank would wait to offer more economic stimulus at least until December, when it will have new forecasts from its own staff.

The surprise move underlined the bank’s newfound flexibility under President Mario Draghi, who took office in 2011. A lower refinancing rate makes it cheaper for banks to borrow from the ECB. The hope is that would encourage banks to charge less for loans, making it easier for companies to expand and create jobs.

“It is obvious that the ECB under President Draghi has become more pro-active than under any of his predecessors,” analyst Carsten Brzeski wrote in a note to investors. The current eurozone inflation rate — well below the ECB’s goal of just under 2 per cent — has also untied the banks’ hands to try further monetary stimulus without fear that it could stoke inflation.

Still, many economists have said a rate cut from the current low level would have a mostly symbolic impact. The problem is that banks in several countries are unable to pass on the lower rate because their own finances are strained.

To help confidence in the banks, the ECB said it also extending its offer of unlimited short-term cheap credit for banks until mid-2015. The offer aims to ensure banks do not run into short-term liquidity problems and can focus instead on lending, which is needed for growth.

The 17 European Union member countries that use the shared euro currency returned to growth in the second quarter, with a modest 0.3 per cent increase in output. High unemployment and cutbacks in government spending in countries dealing with too much debt continue to hold back growth.

The rate cut announcement sent the euro down sharply against the dollar, to $1.3358 from $1.3520 before the announcement. That’s something the ECB won’t mind, as the stronger euro can hold back eurozone exports. Stocks markets in Germany and France were up about 1.5 per cent.

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