The European Central Bank on Thursday lowered its key interest rates, but the reduction was less than expected despite indications that the 16-nation bloc is sliding deeper into recession.
In its meeting held in Frankfurt, Germany, the Governing Council reduced the bank's key interest rate, which is the interest rate on the main refinancing operations, by a quarter percentage point. The reduction took the benchmark rate to an all-time low of 1.25%.
Economists had expected the ECB to lower the rate by a half point.
The central bank also reduced the interest rate on marginal lending facility and that on the deposit facility to 2.25% and 0.25%, respectively. New rates would be effective from April 8.
Economic recession in the Eurozone has deepened despite various stimulus measures. Including the latest cut in the key interest rate, the ECB has lowered a total of three full percentage points since early October 2008.
The Organization for Economic Co-operation and Development forecast the euro area economy will contract by 4.1% in 2009 and by 0.3% next year. Weak export markets, falling investment and a continuing credit crunch will hit Euro area activity hard over the coming six months, it said in its interim forecast.
Thursday's interest rate decision came as leaders of the G20 are meeting in London to discuss ways to get out of the ongoing global economic crisis.
In his regular press conference following the interest rate decision, ECB President Jean-Claude Trichet hinted that further reduction in the key rate is possible, but does not expect to cut deposit rate further.
He said he doesn't care to explain all the reasons why the ECB didn't cut the rate by a half point, but one reason for the quarter-point reduction was to maintain a rate corridor. Trichet added that the bank could narrow the corridor in coming months.
Reflecting the impact of the financial market turmoil, economic activity has weakened markedly in the euro area, as domestic demand has contracted in parallel with the downturn in the world economy, Trichet said. He added that the weak situation is likely to continue for the remainder of this year, but is expected to gradually recover in 2010.
Recent data has shown below-target inflation and rising unemployment in the 16-nation euro area. Annual inflation in March eased to its lowest level since the launch of the euro ten years ago. It now stands at 0.6%. The central bank targets inflation rate of below, but close to 2% over the medium term. The Euro area unemployment rate increased to a near three-year high in February, while economic sentiment hit a fresh low in March.
Trichet said, We expect to see headline annual inflation rates declining further in the coming months and temporarily reaching negative levels around mid-year. Thereafter, annual inflation rates should increase again.
He said in a long-term perspective, annual HICP inflation is expected to remain below 2% in 2010, reflecting mainly ongoing sluggish demand in the euro area and elsewhere.
In addition to the decision on interest rates, there were expectations that the ECB may introduce non-standard measures to ease credit strains as traditional measures approach their limit. Trichet hinted that the rate-setting committee may take additional non-standard measures, if any, in the May meeting.
Non-conventional monetary policy measures are being increasingly embraced in the developed world. In March, the Bank of England had announced a GBP 75 billion-asset purchase scheme to kick-start the UK economy that is slipping deeper into recession, while the interest rates are at record low.
Across the Atlantic, the U.S. Federal Reserve also has adopted quantitative easing measures. In Asia, the Bank of Japan, known for taking to quantitative easing a few years ago, is also buying corporate bonds.
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