ECB unveils radical moves to fight deflation and lift economy

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Mario Draghi became the first major central banker to cut a key interest rate below zero as he unveiled a series of radical measures to stave off a crippling bout of deflation, and signalled his willingness to take further action.

As well as interest rate cuts, the European Central Bank president announced a package of up to €400bn of cheap loans for eurozone banks in an attempt to boost lending to the region’s credit-starved small businesses.

Mr Draghi said that policy makers were still willing to embark on some kind of quantitative easing if ultra-low inflation persists. “Are we finished? The answer is no.” He said the ECB had “decided to intensify preparatory work related to outright purchases” of asset-backed securities, a limited form of bond buying.

“This is really a turning point in the situation of the eurozone,” said Carlo Messina, chief executive of Italian bank Intesa Sanpaolo. He pointed to the ECB’s decision to stop draining liquidity relating to its bond purchases and to the boost that could come from a lower exchange rate.

The combination of the action combined with a signal the bank is prepared to consider QE prompted a rally in global equities, although the euro rebounded after touching a four-month low.

Shares on the FTSE Eurofirst 300, which measures the eurozone’s biggest listed companies, increased by 0.4 per cent, just short of a six-year closing high, while borrowing costs in the region’s indebted periphery tumbled.

Bond yields on benchmark 10 year bonds issued by Spain, Ireland and Italy fell to a record low in the aftermath of Mr Draghi’s remarks, while the premium demanded by investors to compensate them for the risk of investing in Spanish debt instead of German Bunds fell to levels last seen in 2010.

Germany’s Xetra Dax 30 broke above 10,000 points for the first time after Mr Draghi revealed the full extent of the ECB’s measures in his press conference. The euro fell by 0.3 per cent on the day hitting $1.3502 before going back to its initial level.

The overall market response indicated that investors felt the ECB had been “accommodating” according to Steven Major, global head of fixed income research at HSBC.

“It is impressive, given the expectation that had built up before today, that the ECB did not disappoint,” he said.

Carsten Brzeski, economist at ING, said the ECB had ignited “monetary policy fireworks”.

The ECB cut its main refinancing rate to 0.15 per cent, from 0.25 per cent and its deposit rate from zero to minus 0.1 per cent, making it the first major central bank to venture into negative territory.

None of the Federal Reserve, Bank of Japan or Bank of England have tried this, although the ECB hopes the move will lift inflation by weakening the euro and spurring lending in the bloc’s troubled periphery. All of the governing council’s 24 members backed the package.

Acknowledging that almost all of policy makers’ conventional tools were exhausted, the ECB president indicated the governing council would shift to a large-scale programme of asset purchases should inflation remain at worryingly low levels.

Mr Brzeski said: “With rate cuts, new liquidity measures, and some hints at further unconventional measures, the ECB presented a policy package of last hope. This was as far as it could go without getting lost in the uncharted territory of QE.”

The ECB cut its eurozone growth forecast for 2014 to 1 per cent and revised down its forecasts for inflation to 0.7 per cent in 2014, 1.1 per in 2015 and 1.4 per cent in 2016.

Mr Draghi said the ECB will offer cheap loans, known as a targeted longer-term refinancing operations (TLTROs), which will resemble the structure of the Bank of England’s Funding for Lending Scheme. There will be four TLTROs, all maturing by September 2018, worth up to €400bn.

Unlike the Bank of England, however, the ECB has decided to exclude mortgage lending from the scheme.

“The ECB has acted perhaps more slowly than other central banks but with a more targeted approach,” said Alberto Gallo, head of credit research at RBS.

Additional reporting by Elaine Moore, Delphine Strauss and Christopher Thompson in London

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