ECB cuts interest rates to record low

The European Central Bank has cut interest rates for the first time in 10 months, promising to provide as much liquidity as eurozone banks need well into next year and to help smaller companies get access to credit.

The ECB lowered its main interest rate on Thursday by a quarter percentage point to a record low 0.50 percent in response to a drop in eurozone inflation well below its target level, and rising unemployment.

The cut was widely expected after President Mario Draghi said last month that the ECB stood ready to act, a phrase he repeated on Thursday, but few economists expect it to make a decisive difference.

Acknowledging that, the ECB said it would prime banks with as much liquidity as they need until at least July 2014 and look at ways to boost lending to smaller companies, which are the lifeblood of Europe’s economies but which in many countries have been starved of credit.

“Weak economic sentiment has extended into the spring of this year,” Draghi said.

“Our monetary policy stance will remain accommodative for as long as needed.”

Downside risks

Draghi stuck with the ECB’s forecast that economic recovery will take hold later in the year but highlighted “downside risks” to that position.

The ECB would “monitor very closely” all incoming evidence, Draghi said, a phrase which in the past has suggested further policy action to come.

He added that there was a strong consensus to cut rates, indicating one or more policymakers did not agree.

Unemployment hit a record high in March and annual inflation plunged to 1.2 percent in April, pressuring the ECB to cut rates to honour its mandate to deliver price stability, which it defines as inflation close to, but below 2 percent.

“The ECB is playing it safe, even though they know the effect is likely to be limited,” Nordea analyst Anders Svendsen said of the cut.

The sudden slump in price pressures has also raised the possibility of the ECB having to look at policy tools beyond interest rates to counter any further slide in inflation.

“Ultimately, we think the ECB will have to purchase private-sector assets in order to fix the transmission mechanism,” said Andrew Bosomworth at PIMCO, the world’s largest bond fund.

Safe haven German Bund futures hit a new record high at 146.99 as Draghi spoke.

Small companies, big problem

The ECB wants to improve the transmission of its monetary policy so its low rates reach all corners of the eurozone.

The bloc’s south is not benefiting to the same extent as the north from the ultra-low rates.

If they are lending at all, banks there are charging companies and households more for loans than their peers in the north because of higher funding costs and credit risks.

“There can’t be fears of lack of funding as an excuse for not lending,” Draghi said after the policy meeting in Bratislava, one of two that the ECB holds outside of Frankfurt each year.

The ECB has repeatedly voiced its concern about the impact this has on lending to small and medium-sized enterprises (SMEs), which have little alternative to bank funding.

The ECB wants to revive an asset class that has widely been blamed for causing the financial crisis – asset-backed securities (ABS).

This asset class allows banks to pass at least some of the credit risk on to other investors as they try to boost their capital and liquidity buffers to adapt to new regulatory standards, one reason for their reluctance to lend.