ECB cuts rates to avert deflation

The European Central Bank (ECB) surprised financial markets on Thursday by paring back its key interest rates to new all-time lows to ward off deflation, and it also cut growth forecasts.

The news sent the euro down by more than a cent against the dollar to the lowest level in 13 months.

The head of the ECB, Mario Draghi, also said at a later press conference that the bank would launch a programme to purchase asset-backed securities, a major policy development which the markets had expected.

The bank would launch further measures if needed to ward off the threat of inflation, he assured, while also revealing that the bank had cut its eurozone growth forecasts for this year and next.

Against a background of growing concern that the single currency area is on the verge of dangerous spiral of falling prices, the ECB cut its central "refi" refinancing rate to 0.05% from 0.15%.

It also lowered the deposit rate to minus 0.2% from minus 0.1% and trimmed its marginal lending rate to 0.3% from 0.4%, it said in a statement.

Few analysts had expected any further rate cuts this month, arguing that, with eurozone borrowing costs already at record lows, a cut would not prove particularly effective.

Many observers had expected the ECB to embark on a policy of what is known as "quantitative easing" or "QE", a radical policy -- already used by other central banks such as the US Federal Reserve -- of buying securities on a big scale to inject cash into the economy.

- QE or ABS -

But they said it might opt for a narrower scheme of asset-backed securities (ABS) purchases.

The pressure has increased on the ECB to act after eurozone inflation slowed to just 0.3% in August from 0.4% the previous month.

The latest data puts inflation worryingly below the central bank's target of just under 2% and brings the single currency area perilously close to deflation.

This is a climate of falling prices which can cause businesses and consumers to delay purchases, further reducing demand and prices and pushing up unemployment.

But there is resistance to QE because it would entail the ECB buying up sovereign bonds, which many critics -- including the German central bank or Bundesbank -- view as monetary financing, or printing money to pay a country's debt.

And the ECB is expressly forbidden from doing that.

ECB watchers felt the additional rate cuts were therefore a way for the central bank to duck a programme of QE for now.

It "looks like a stop-gap ahead of more powerful stimulus measures to be unveiled in the coming months," said Capital Economics economist Jonathan Loynes.

"But these moves are no substitute for the much more powerful policy action which looks increasingly necessary to prevent a renewed recession," the expert continued.

He therefore expected Draghi to "drop some heavy hints of further action .... An ABS purchase programme still appears to be at the top of the list, but Draghi will also keep the door wide open to a full-scale quantitative easing programme."

Asset-backed securities are bundles of individual loans such as mortgages, auto credit and credit-card debt that are sold on to investors, allowing banks to share the risk of default and encouraging them to offer more credit.

Draghi has repeatedly said that preparations for such a programme are underway.

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