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Interest rate cut to stimulate EU economies

Jul 05 2012 15:33 AFP

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Frankfurt - The European Central Bank (ECB) pared back interest rates on Thursday to give a push to progress made by EU leaders in fighting the crisis at their summit last week.

The ECB, at its regular monthly policy meeting, trimmed eurozone borrowing costs to a new record low of 0.75%.

The two other key rates, on the marginal lending facility and the deposit facility, would also be cut to 1.50% and 0% respectively.

Shortly before, the Bank of England (BoE) announced it would increase its Quantitative Easing (QE) stimulus policy by £50bn ($78bn, €62bn) to boost Britain's recession-hit economy.

And the BoE added that it was keeping its main interest rate at a record low 0.50%.

ECB president Mario Draghi was scheduled to explain the reasoning behind the decision at the traditional post-meeting news conference, but both the ECB and the BoE moves had been widely been flagged by analysts and priced in by the markets.

Analysts said that in cutting rates, the ECB will help shore up the relatively positive sentiment on financial markets since the EU summit, which delivered more than originally hoped for in moves to break the debt crisis.

ECB watchers were now waiting to see whether the central bank will unveil more of what it terms "non-standard" measures in the fight against the crisis.

A hotly contested programme of indirectly buying up the bonds of debt-mired countries, known as the Securities Markets Programme (SMP), has lain dormant for 16 weeks now.

The ECB also appears reluctant to embark on further massive injections of liquidity while the effects of two previous ones in December and February amounting to more than €1.0 trillion ($1.26 trillion) have still to make themselves fully felt.

Capital Economics economist Jennifer McKeown saw the move as "largely symbolic."

The cut "does little to alter the bleak economic outlook and the ECB is unlikely to announce any bolder unconventional measures for now," the analyst said.

The move was "at least ... a sign of support from the ECB, confirming that it has taken the recent downturn in indicators of economic activity seriously," McKeown said.

"But president Draghi is unlikely to announce any further unconventional policies. The ECB will probably wait to judge the effect of earlier long-term loans and the latest loosening of collateral requirements before doing any more for banks," she argued.

"And crucially, it is likely to remain strongly opposed to supporting the peripheral economies with more sovereign bond purchases, which it believes are the responsibility of other eurozone governments," the economist concluded.

The German banking federation BdB said the rate cut was "comprehensible, given the weakness of the eurozone economy and easing inflation pressures."

Nevertheless, "the economic effects of a cut in interest rates that are already so low must not be over-estimated," said BdB chief Michael Kemmer.

The move would nevertheless buy time for the politicians to solve the crisis, he argued.

"Monetary policy cannot replace the structural reforms that are so urgently needed in some eurozone countries, nor can it remedy the markets' lack of confidence in state finances," Kemmer said.

Furthermore, there were dangers connected with excessively low interest rates over long periods of time and very ample liquidity in the financial system, he argued.

Banks could delay their restructuring efforts and low interest rates could also distort investors' risk assessments, Kemmer suggested.

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