FRANKFURT – The European Central Bank on Thursday entered into uncharted territory in its battle against deflation, taking one of its key interest rates into negative territory for the first time.
The ECB said in a statement that it is lowering all three of its key interest rates, which have been on hold at record lows all this year.
The bank’s decision-making governing council voted to lower the central refinancing rate to 0.15 percent from 0.25 percent previously.
The interest rate on the marginal lending facility was trimmed to 0.40 percent from 0.75 percent.
And the deposit rate — the rate at which the central bank pays commercial banks for depositing their unused cash — was reduced from zero percent to minus 0.10 percent.
This means that banks will be charged for the privilege of, or be discouraged from, parking funds in an effort to push cash through banks and into loans to businesses and consumers.
The moves had been widely anticipated by the financial markets after leading ECB officials, including President Mario Draghi, repeatedly hinted at such measures in recent weeks.
Draghi was scheduled to explain the bank’s reasoning at a news conference later and was also expected to unveil additional policy measures to boost credit in the 18 countries that share the euro.
“The ECB just did it and entered new unchartered territory in its quest to support the eurozone economy,” said ING DiBa economist Carsten Brzeski.
“Will it help to kick-start the economy? Probably not, but at least it demonstrate the ECB’s determination and ability to act,” the expert said.
IHS Global Insight analyst Howard Archer said the moves came as “no surprise at all and is thoroughly justified by the mounting risk of persistent very low eurozone inflation morphing into deflation.”
Area-wide inflation slowed to just 0.5 percent in May, way below the ECB’s target of close to, but just below, 2.0 percent. This has fueled concern that the single currency area is on the brink of deflation — when consumer prices fall for a broad range of items over a sustained period.
During a period of deflation, people and businesses tend to postpone purchases while hoping for further price declines in the future. This can thus push an economy into a vicious spiral of falling growth and rising unemployment, and is notoriously difficult to reverse.
IHS analyst Archer suggested that the cuts could be seen as being “on the tentative side, although the ECB will likely want to tread very carefully on the negative deposit rate front.”
Nevertheless, he saw it as a “bold and unusual move.”
“While the ECB has previously seemingly balked at taking its deposit rate into negative territory and has been concerned about possible unwanted repercussions, the ECB now clearly believes that a full lowering of the interest rate corridor — rather than just a trimming of the refinancing rate — is the most effective way of trying to soften the euro and to encourage banks to pick up their lending to the private sector,” Archer said.
Natixis economist Cedric Thellier said he expected Draghi to announce “a package of further unconventional measures,” such as pumping liquidity into the financial system by way of long-term refinancing operations, or LTROs.
It already did so at the end of 2011 and the beginning of 2012.
But at that time, banks did not lend the cash on to the SMEs that form the backbone of the eurozone economy. So this time round, the ECB is likely to attach conditions to the loans, ECB watchers said.
Another course of action would be to embark on so-called quantitative easing, a policy already pursued by other central banks, such as the Bank of England, the U.S. Federal Reserve and the Bank of Japan.
Such a measure was long a taboo at the ECB, because it was seen as an effective license to print money, which is expressly forbidden in the bank’s statutes.
The ECB’s chief economist, Peter Praet, had said in May that QE would only be an option “if the economy and inflation develop significantly worse than we expect.”
And that was unlikely to be the case just yet, analysts insisted.