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ECB slashes key rate to kick-start Europe’s flagging economy

File photo Head of the European Central Bank, ECB, Mario Draghi.

Boris Roessler/AP

Continental Europe's distress has forced the region's central bank into aggressive measures that underscore a growing divide between the Old World and the New.

The European Central Bank moved Thursday to revive the economy by cutting interest rates to a record low, marking its second reduction in three months, and unveiled a program to buy asset-backed securities (ABS). Its goal is to prevent disinflation from sliding into deflation – or falling prices – revive growth and prompt commercial banks into opening up stalled lending operations.

The central bank's moves, accompanied by a new, bleaker forecast for economic growth, are yet another effort to trigger a sustained recovery, bring down near record-high unemployment and restore business and consumer confidence.

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They also mark a new chapter in the saga of the troubled euro zone, whose recovery appeared intact a year ago, only to evaporate as economic reforms went missing, industrial overcapacity remained high, sovereign debt rose and geopolitical tensions, such as the Ukraine crisis, rattled investors. Europe's troubles, and its actions, are far different from those of many other countries, including the United States and England, where economies are perking up and jobless rates are easing.

Others, such as many in Asia, are also faring better.And while the EBC adds stimulus, the Federal Reserve, for one, is pulling back, reducing its quantitative-easing program, with expectations of a rate hike next year. The Bank of England's next move is also expected to be a rate increase.

The ECB reduced its main refinancing rate to 0.05 per cent, a drop of 10 basis points. It dropped the deposit rate by the same amount, to minus 0.2 per cent, meaning banks will now pay twice as much to park their money overnight at the ECB. Negative deposit rates are designed to encourage banks to lend out money instead of storing it.

ECB president Mario Draghi said the purchase of asset-backed securities, such as bundled mortgage loans, from banks and possibly institutional investors, were "predominately" aimed at easing credit. Slow lending growth has taken a lot of the blame for the slow-motion recovery. The program is to start in October, but the ECB would not confirm its details, such as its size and duration, saying full information about the purchases will be revealed at the next policy meeting in early October.

The ABS program will fall well short of full-scale U.S.- and British-style quantitative easing, as the European ABS market is relatively small and sovereign bonds will not be purchased. Mr. Draghi said the ABS decision was not unanimous, but would not identify the naysayers. It is well known, however, that Germany has resisted any form of quantitative easing; it continues to advocate a tough package of austerity and economic reform measures.

Some economists considered the rate cuts and the ABS program inadequate measures to stave off a prolonged economic stagnation.

"Today's ECB moves are a step in the right direction, but too little, too late to snuff out deflation risk and kick-start growth," said Hermes Group chief economist Neil Williams. "The further 10 [basis points] shavings off the refinancing and deposit rates are puny, and look more cosmetic than real. Any drop in the euro on the back of them would be welcome, but possibly short lived."

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But other economists noted that the rate cuts and ABS announcement did have an immediate positive effect by sending the euro spiraling downward. By the end of European trading on Thursday, the currency used in 18 European Union countries had lost 1.6 per cent, taking it to its lowest level since mid-2013 and raising its loss to more than 5 per cent since the start of July. "The lower exchange rate will undoubtedly provide a boost to exporters' competitiveness," aid Chris Williamson, chief economist and market and trading data company Markit.

Mr. Draghi said the ECB now expects euro zone growth of just 0.9 per cent this year, down from its previous forecast of 1 per cent, and 1.6 per cent next year, down from 1.7 per cent. But apparently optimistic that the recovery will get stronger, it raised the 2016 growth forecast marginally to 1.9 per cent.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More


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