ECB cuts key interest rates ahead of EU summit

Updated: 2011-12-09 04:30


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FRANKFURT - The European Central Bank (ECB) lowered its benchmark interest rate back to its historic low of 1.0 percent Thursday, with the announcement of several non-standard measures aimed at curbing an expected mild recession and avoiding a credit crunch over the debt crisis.

The central bank's decision came just hours before European Union (EU) leaders headed to Brussels for a make-or-break EU summit, hoping to beat the crisis through crucial treaty changes and tougher fiscal disciplines, as proposed by eurozone's two leading economies Germany and France.

The rate reduction was in line with markets forecast. After two turning-ups in April and July, the benchmark interest returned to its record low level of 1.0 percent, which was maintained for 11 consecutive months since May 2009 during the international financial crisis, when the current debt crisis seemed entering into a do-or-die phase that threatened the existence of the eurozone.

Markets had also expected the ECB would boost its bond purchase in the secondary market as the EU leaders are on their way to reach a consensus on tighter budget control.

However, ECB chief Mario Draghi said in a press conference after the rate-cutting decision that there is no necessary connection between ECB's operation and eurozone governments' promises.

Although the ECB has restarted the buying in August, the bank insisted that the move was unconventional and temporary, keeping the purchase in a limited amount. Draghi repeatedly said that it is up to the eurzone governments themselves to restore and consolidate their finances.

Nevertheless, Draghi did offer new firepower to support the cash-starved banks and nervous investors, saying that the ECB would conduct two longer-term, rate-fixed refinancing operations (LTROs) with a maturity of 36 months and the option of early repayment after one year.

The ECB also decide to lower the rating threshold for certain asset-backed securities to increase collateral availability for banks, and to free up collateral by reducing the reserve ratio from currently 2 percent to 1 percent.

"These measures should ensure enhanced access of the banking sector to liquidity and facilitate the functioning of the euro area money market," said Draghi, who just took over the post from Frenchman Jean-Claude Trichet in November and are viewed as "a man of action" by insiders.

He also stressed that all the non-standard monetary policy measures are "temporary in nature."

While the eurozone inflation remained at 3 percent for the third month in a row in November, well above the ECB target of "keeping the inflation close to but below two percent," Draghi said that the inflation is likely to decline to below 2 percent next year "in an environment of weaker growth in the euro area."

According to Eurosystem staff macroeconomic projections, the inflation for the euro area would be between 2.6 percent and 2.8 percent for 2011, between 1.5 percent and 2.5 percent for 2012.

The ECB also lowered its economic growth outlook for the 17-nation eurozone, saying that annual real gross domestic product (GDP) growth would be between minus 0.4 percent and 1.0 percent in 2012, much lower than its previous forecast of 1.3 percent next year.

"The intensified financial market tensions are continuing to dampen economic activity in the euro area and the outlook remains subject to high uncertainty and substantial downside risks," stemming from the sovereign debt crisis, as well as downward revisions of foreign demand, Draghi said, ringing new alarms to the European leaders after international credit rating agency Standard & Poor's placed the entire EU on downgrade watch on Wednesday.

Draghi called on European governments to "do their utmost to support fiscal stainability in the euro area as a whole," saying that a new fiscal compact with tighter and clearer rules is "the most important precondition for restoring the normal functioning of financial markets."