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European Central Bank cuts key interest rate to new low
Question of the Day
FRANKFURT, Germany — The European Central Bank cut its key interest rate by a quarter percentage point Thursday to a record low 0.75 percent to try to help ease Europe's financial crisis and boost its sagging economy.
The action, which was widely expected, is meant to make it cheaper for businesses and consumers to borrow and spend money. But experts said that fear over the economy was so high in Europe that the cut might only have limited effect.
In a more surprising move, the ECB cut the interest rate it pays banks on overnight deposits by a quarter percentage point — to zero. This pushes banks to lend the money, rather than sock it away with the ECB.
ECB President Mario Draghi said the eurozone economy would recover only gradually. Some of the risks foreseen from the debt crisis had already materialized, pushing the bank to act, he said.
Analysts warned the rate cut might do little to jolt the eurozone economy back to life, however. Borrowing rates are already low, but businesses and households are not spending money because they are afraid of the economic outlook.
Draghi said there is more the ECB could do to stimulate growth — "we still have all our artillery ready" — and that low inflation gives the bank more wiggle room. However, he suggested no further actions were imminent.
Stock markets initially rose after the news, but the gains faded as investors worried about a slowdown in the global economy. Germany's DAX stock index fell 0.5 percent and the Dow 0.2 percent. The euro was down 1.1 percent at $1.2380.
"Today's ECB interest rate cut does little to alter the bleak economic outlook," said Jennifer McKeown, analyst at Capital Economics.
She said the ECB is likely to now wait and see how the financial markets and the economy react to the rate cut and to the new emergency measures announced by European leaders last week.
The leaders agreed to make it easier for troubled countries and banks to receive rescue loans from Europe's bailout fund and also signaled greater willingness to use emergency funds to purchase government bonds. The goal would be to drive down troubled countries' borrowing costs. They also agreed to create a single Europe-wide banking regulator to prevent bank bailouts from wrecking individual countries' government finances.
Collectively, the moves sent a message to financial markets that leaders from the 17 countries that use the euro could work together to fix their problems. They also helped lower the high borrowing costs for financially stressed countries such as Italy and Spain, the euro region's third- and fourth-largest economies.
Lending activity in the eurozone has remained weak because businesses are not asking for credit because of the slow economy and out of fear that the eurozone may suffer a further financial calamity. Concerns remain that bankrupt Greece could eventually leave the euro, causing more turmoil, or that Spain and Italy could need bailouts that would strain the resources of donor countries.
Joerg Kraemer, chief economist at Commerzbank, said the cut wouldn't fix what was wrong. The reason the eurozone economy is weak is not because of "high ECB rates but because of uncertainty stemming from the sovereign debt crisis. This can't be cured by lower rates."
The cut to the refinancing rate will give some further relief to banks by lowering the rate they pay on the €1 trillion in cheap emergency loans they took from the ECB Dec. 21 and Feb. 29, the bank's chief emergency measure. The rate on that money is the average refinancing rate over the life of the loan, which can be up to three years. Lower costs on that money means they can earn more when they use it to buy higher yielding investments such as government bonds.
The cut in the deposit rate is meant to push banks to stop using the ECB as a safe haven by parking money there overnight. Before the debt crisis exploded, banks would deposit about €50 billion with the ECB overnight. That ballooned as the crisis made banks wary of investing or lending money. On Wednesday, banks had placed €790 billion with the ECB overnight.
There are other safe havens for banks to place their money — government bonds of financially strong countries like Germany, for example. But a central bank is considered the ultimate safe haven since it can print money at will.
The eurozone crisis has battered investor confidence for 2 ½ years. It has seen Greece, Ireland and Portugal need bailouts from the other eurozone countries and the International Monetary Fund to keep paying their debts and covering their budget deficits. Spain has asked for as much as €100 billion in rescue loans for its banks.
Earlier in the day, the central banks of China and Britain took action to stimulate their economies.
The Bank of England decided to purchase another 50 billion pounds in government bonds from financial institutions. The hope is that the banks will use the extra cash to lend to businesses and households.
China's central bank, meanwhile, cut interest rates for the second time in a month to shore up its economy, the second-largest in the world. Interest on a one-year loan was reduced by 0.31 percentage points to 6 percent effective Friday. Chinese authorities have rolled out a series of stimulus measures since March after economic growth slowed to a nearly three-year low of 8.1 percent in the first quarter.
In the U.S., weak economic indicators have raised speculation that the U.S. Federal Reserve may also have to do more to keep the U.S. economy growing. Some think the Fed might carry out a third round of bond purchases aimed at driving down interest rates on business and consumer loans.
The Fed took more limited action at its meeting ending June 17, extending its so-called Operation Twist effort in which it sells short-term bonds and buys longer-dated issues to push down long term interest rates. The Fed meets next Aug. 1.
By Andrew P. Napolitano
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