The European Central Bank cut interest rates to record lows on Thursday (5 June), imposing negative rates on its overnight depositors to cajole banks into lending more and to fight off the risk of Japan-like deflation.
The ECB launched a raft of measures to fight low inflation and boost the euro zone economy. It lowered the deposit rate to -0.1%, meaning it will effectively charge banks for holding their money overnight. It cut its main refinancing rate to 0.15%, and the marginal lending rate – or emergency borrowing rate – to 0.40%.
“Now we are in a completely different world,” Draghi told a news conference, citing “low inflation, a weak recovery and weak monetary and credit dynamics”. The package, adopted unanimously, was aimed at increasing lending to the “real economy”, he said.
French Finance minister, Michel Sapin, welcomed the ECB move. “These decisions give a strong signal and provide welcome support to growth in France and in the euro area, in a context of fiscal consolidation. They will create conditions more favorable financing firms and households, and therefore investment,” he said.
“I will make sure that French companies get from their banks, or directly on financial markets, the low-cost loans they need,” he added.
Just hours before the ECB policy decision, a Bank of Japan policymaker sounded a warning, saying the eurozone should not take lightly the potential danger of slipping into a Japan-style deflationary period.
The eurozone economy is only growing at 0.2%. Consumer spending, investment and exports are all growing at a slower pace than this time last year. Inflation in the Eurozone fell to 0.5% in May, down from 0.7% in April. This is well below the European Central Bank’s 2% target.
Other steps included extending the duration of unlimited cheap liquidity for euro zone banks, injecting about €170 billion by stopping tenders that withdrew funds spent on on past government bond purchases, and preparing for possible future purchases of asset-backed securities to support small business.
Projections published by the ECB showed inflation would be just 0.7% this year, 1.% next year and 1.4% in 2016, a downward revision and far below the ECB’s target of below-but-close-to 2%.
“If required, we will act swiftly with further monetary policy easing,” he said, adding that the policy-setting Governing Council was unanimous in its commitment to use unconventional instruments if needed “to further address risks of too prolonged a period of low inflation”.
Financial markets saluted the ECB measures, even though most of them had been widely anticipated for weeks. The euro fell to a four-month low of $1.3505, down about one cent, after his statement. European shares rose and yields on the government bonds of stressed euro zone countries fell.
German Chancellor Angela Merkel declined comment, noting that the ECB took its decisions independently of governments. Her finance minister, Wolfgang Schaeuble, said low interest rates were not a long-term solution.
Low rates are unpopular in Germany, Europe’s biggest economy, because they are seen as penalising savers.
Conservative German economist Hans-Werner Sinn of the Ifo institute said the ECB’s moves smacked of desperation and would not work.
“This is a desperate attempt, with ever cheaper money and penalty rates on deposits, to shift capital flows to southern Europe in order to stimulate growth there,” he said.
Draghi said interest rates would stay low for a prolonged period but after Thursday’s cut, he omitted a previous regular line that they could go lower.
Asked how long it would take for the measures to work their way though into the economy, he said: “Most likely we will see immediate effects in the money markets and we will see delayed effects in the real economy attributable to this programme … It will probably take three or four quarters.”
A slowdown in the eurozone's economic recovery in the first quarter reinforced calls for bold actions by the European Central Bank. The eurozone economy expanded by just 0.2% in the three months to March, the EU's statistics office Eurostat said.
Euro zone inflation has been stuck in the European Central Bank's 'danger zone' of below 1% since October and coupled with weak growth poses a risk for the recovery.
Growth in the first quarter rise was mainly due to Germany, which compensated the stagnation in France and the shrinking output in Italy, the Netherlands, Portugal and Finland. The quarterly rise was driven mainly by change in inventories, along with domestic and government consumption and exports. Imports did little to help the economy.
When compared with the same period of last year, the economy grew by 0.9%, its second consecutive annual expansion after a 0.5% increase in the last quarter of 2013.
Separately, Eurostat data showed that industrial producer prices, a proxy for consumer price inflation, fell as expected both on the month and year on year in April. Prices at factory gates in the euro zone slid 0.1 percent on the month in April after a 0.2 percent drop in March, showing the fourth consecutive monthly decline in a row.
Out of the bloc's five largest economies, Germany, France, Italy, Spain and the Netherlands, it was only Madrid seeing prices going up month-on-month by 0.2%. When compared with the same period last year, producer prices fell by 1.2% in April, slowing from a 1.6% drop in March.