Thursday, the European Central Bank cut its benchmark interest rate to a new low as the 16-nation economy faces its worst recession since the World War II.
At its meeting in Frankfurt, the Governing Council, the policymaking body of the ECB, reduced the interest rate on the main refinancing operations of the Eurosystem by 25 basis points to 1.00%, effective May 13. The decision was in line with expectations. In the April session, the key interest rate was lowered by a quarter point.
It is widely believed that the central bank would hold fire for a long period after today's rate cut. The ECB has lowered interest rates by a total of three and a quarter percentage points since early October 2008.
Governing Council member Ewald Nowotny recently said the central bank will keep the interest rate very low for as long a time as is required, and stands ready to use non-conventional measures of quantitative easing to assure European firms and consumers access to credit at appropriate conditions.
Meanwhile, the central bank cut the interest rate on the marginal lending facility by 50 basis points to 1.75% today. On the other hand, the interest rate on the deposit facility was left unchanged at 0.25%.
The President of the ECB Jean-Claude Trichet is set to hold a press conference at 8.30 am ET. He is widely expected to announce further non-standard measures.
The ECB was widely expected to announce non-conventional policy measures after its April rate-setting session. However, that did not happen and Trichet said he would announce full details of any further non-standard measures after the next session. He also hinted at possible rate cuts, saying he is not ruling out a measured approach to take the key interest rate down further.
Making the task difficult for ECB, the Governing Council is apparently divided on whether to cut the rate below 1% or adopt unconventional measures. Some ECB policymakers do not favor a benchmark interest rate below 1%. Germany's Axel Weber is of the view that if the interest rate falls below 1%, banks will have no incentive to lend to each other, paralyzing interbank lending. Italy's Lorenzo Bini Smaghi has also voiced a similar opinion.
Economists largely expect the central bank to have ruled out purchase of government bonds. The central bank is widely expected to extend the maturities on its loan to banks from the current limit of six months.
Central banks in the UK, the U. S. and Japan are buying bonds under their quantitative easing policies. The Swiss central bank has increased the number of long-term repo transactions. Further it is purchasing Swiss franc bonds issued by private sector borrowers and buying foreign currency on the open market.
Earlier on Thursday, the Bank of England left its key interest rate unchanged at 0.5%. Further, the central bank announced that it is continuing with its scheme of asset purchases financed by the issuance of central bank reserves and decided to increased its size by GBP 50 billion to a total of GBP 125 billion.
On Monday, the European Commission sharply lowered the GDP outlook for the euro area, which is now expected to contract 4% in 2009 and 0.1% next year. In its interim forecast in January, the commission said the euro area will contract 1.9% in 2009 and will grow 0.4% in 2010. The euro area unemployment rate is forecast to rise to 11.5% from 9.9% this year. The International Monetary Fund expects the Eurozone to contract 4.2% this year.
Policymakers expect headline annual inflation rate to decline further in the coming months and temporarily reach negative levels around mid-year. Eurozone inflation remained at a record low of 0.6% in April, a flash estimate from Eurostat showed last week. The central bank targets inflation rate of below, but close to 2% over the medium term.
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