ECB cuts interest rates on fears of European recession

November 3, 2011

The European Central Bank cut key interest rates in a surprise move Thursday, aiming to bolster the ailing economies among the 17 nations that use the euro currency.

The ECB was responding to new signs that the European economy could be falling into recession, shrinking confidence in the continent’s financial stability. Countries are slashing spending and raising taxes to reduce budget deficits and strains in financial markets, and the political situation in troubled Greece is on the edge of crisis. It was a reversal for the central bank, which earlier this year had increased rates by half a percentage point to address the risk of inflation.

“What we are observing now is slow growth heading toward a mild recession by year end,” Mario Draghi said during a news conference after his first policy meeting as ECB president. The central bank cut its main policy rate to 1.25 percent from 1.5 percent, contradicting analysts’ expectations that the rate would not be changed.

It was only the third day on the job for Draghi, who with the Federal Reserve’s Ben S. Bernanke is now one of the world’s two most powerful central bankers. The former head of the Bank of Italy takes charge at a time when the two-
decade track toward a common European currency is in peril.

Some analysts argued that the ECB’s action, while a pleasant surprise, may be too little, too late to avert an economic downturn in Europe.


The decision suggests that the central bank is “starting to acknowledge the effects of the region’s debt crisis on the wider economy,” Jennifer McKeown of Capital Economics said in a report. “But, for now at least, the Bank remains unwilling to take the bolder steps that would be required to prevent the crisis deepening.”

On Thursday, Greek Prime Minister George Papandreou backed away from a proposed referendum on whether the nation should adopt the tough austerity measures that European officials are demanding as a condition of a new round of bailout funds or abandon the euro currency altogether. Papandreou’s retreat came after Greek’s main opposition party agreed to a bailout in exchange for new elections.

Asked during his news conference about the possibility of Greece leaving the euro zone, Draghi replied tersely, “It is not in the treaty,” referring to the pact that European nations signed in adopting the common currency. The treaty does not stipulate any method for a country to leave the monetary union.

Even as the Greek government appears at risk of collapse, economic and financial strains are hitting Europe in a broad way. In particular, investors have showed new doubts about Italy, the third-largest economy on the continent and the nation with the most debt outstanding.

The rate Italy must pay to borrow money has risen sharply in the past two months, to 6.2 percent for a 10-year bond, from 4.9 percent in mid-August. The European Central Bank has helped keep those rates down by buying the debt of Italy and other troubled governments. But whether to continue and even expand the debt purchases is a fraught issue for Draghi, who is both new on the job and Italian. His predecessor, Jean-Claude Trichet, is from France, a nation facing less of an overhang of debt.

Indeed, Draghi specifically rejected the idea that the ECB would serve as the “lender of last resort” to troubled European governments. Throughout history, central banks have frequently played that role, lending to governments when private markets lose confidence. The ECB is prohibited from financing governments by its founding treaty but has repeatedly bought government bonds on public markets in the past 18 months to try to stem the financial crisis.

“What makes you think that becoming the lender of last resort for governments is what you need to keep the euro region together?” Draghi said at the news conference. “That is not really in the remit of the ECB. The remit of the ECB is maintaining price stability in the medium term.”

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