The European Central Bank on Thursday lowered its key interest rate by 25 basis points to a new low of 1.25%, defying expectations for a larger reduction of 50 basis points.

In its meeting held in Frankfurt, the Governing Council of 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.

In March, the ECB had resumed the process of decreasing interest rates after pausing in February. The central bank had lowered the rate to 1.5% from 2%. The March level was the lowest level in the institution's 10-year history.

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.

The Organization for Economic Co-operation and Development forecast the euro area GDP to drop 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.

ECB President Jean-Claude Trichet is expected to hold his regular post-meeting press conference at 8.30am ET.

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