Draghi jolts markets with surprise rate cut

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The European Central Bank cut interest rates by a quarter point to 1.25% in a surprise move on Thursday (3 November), acting boldly to support the ailing eurozone economy at the first policy meeting where President Mario Draghi's was in charge.

The Italian has walked into a maelstrom in his first week at the ECB's helm, with eurozone leaders contemplating a future without Greece and economic policy paralysis in his home country threatening to push Rome into the eye of the storm.

But he offered no commitment to scale up the central bank's bond-buying programme to support the likes of Italy and Spain.

"What we are observing now is ... slow growth heading toward a mild recession by year-end," Draghi told a news conference.

"A significant downward revision to forecasts and projections for average real GDP growth in 2012 [are] very likely," he added.

Global markets rose after the annoucement that coincided with Greek Prime Minister George Papandreou's decision to scrap a national referendum on the European rescue plan for his country.

The decision to cut rates was unexpected and came despite inflation in the 17-country eurozone staying at 3.0% for a second month running in October, well above the ECB's target of just below 2%.

Draghi said the ECB expected inflation to subside below 2% next year.

"What a starter. It is obvious that the ECB has caught the crisis virus and is trying everything it can to prevent a full-fledged recession," ING economist Carsten Brzeski said.

European leaders said earlier they were prepared for Greece to leave the eurozone to preserve the 12-year-old single currency if Athens does not decide quickly to implement a bailout program, putting the likes of Italy and Spain, and even France, firmly in the markets' sights.

Draghi headed to the G20 Summit in Cannes, France, after his debut news conference as ECB chief.

Europe's ultimatum to Greece, after Prime Minister George Papandreou's decision to call a referendum on a bailout plan, has deepened the crisis and raised pressure on the ECB, which many analysts see as the only institution with the firepower to bring calm.

No shift on bond buying

Draghi gave no hint that the ECB's bond-buy programme, a controversial tool that has led to the resignation of two German policymakers, would be accelerated despite the chaos in Greece threatening to engulf the much larger economies of Italy and Spain.

"Our securities market program has three characteristics: it is temporary; it is limited; it is justified in restoring the functioning of monetary transmission channels," he said.

Draghi succeeded France's Jean-Claude Trichet as ECB chief on Tuesday – a day that saw the ECB buy Spanish and Italian bonds but barely manage to cap a rise in yields on the debt of the eurozone's third largest economy.

He must balance an eagerness to curry favour with the German contingent at the ECB against growing financial market pressure to intervene on a bigger scale to lower the borrowing costs of Italy and Spain.

The premiums investors have to pay to hold Italian and French 10-year government debt over benchmark German Bunds rose on Thursday with signs growing that the Greek government may fall.

Trichet had signalled previously that the ECB was keen to withdraw from the bond-buying policy once the eurozone's rescue fund, the European Financial Stability Facility, gained new powers to intervene on bond markets.

Draghi said the ECB was "closely monitoring" developments in Greece.

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British Liberal MEP and Chair of the Parliament's economic and monetary affairs committee Sharon Bowles said in a press release that the rate cut was "a bold move by the new President Mario Draghi and shows we can trust the ECB to do its part in safeguarding the stability of the euro."

"‪The economic situation is additionally difficult due to the ongoing developments concerning the Greek bailout and referendum. It is also proving difficult to promote growth and against that background moves such as this interest rate cut are helpful," she added.

Secretary General of the European Trade Union Confederation (ETUC) Bernadette Ségol said: "The cut today can only be a start to further monetary easing. It does not entirely offset the wrong decisions which were taken in the spring, and which we criticised."

"Uncertainty about growth and employment prospects has to be tackled as the priority. Europe must not fall into a double-dip recession," she added.

Michael Kemmer, chief executive of the German Banking Association, warned that the rate cut would only have a limited effect. Instead he said, "Convincing reforms will be required in the highly indebted euro-countries to reduce risk."

Guntram Wolf, deputy director of the Brussels-based economic institute Bruegel, welcomed the move and added that further rate cuts were likely.

"It's not going to be the end. I think he will have to cut again and probably in December or at the latest in January. I would expect another rate cut by at least 25 basis points," he said.

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