Markets: News  

ECB cuts rates; BOE boosts quantitative easing

FRANKFURT (MarketWatch) -- Europe's major central banks delivered a further round of monetary stimulus in the face of a deepening slowdown Thursday, with the European Central Bank cutting its key lending rate to a record low and the Bank of England embarking on additional quantitative easing.

China's central bank, meanwhile, surprised markets by cutting its benchmark lending and deposit rates. See: People's Bank of China cuts lending, deposit rates.

The ECB cut its key lending rate by a quarter of a percentage point to 0.75%, taking it below 1% for the first time in the central bank's history.

The central bank also cut the deposit rate, which it pays on funds parked at the ECB overnight, to 0% from 0.25% and lowered the rate on its marginal lending facility from 1.75% to 1.5%.

Draghi, speaking to reporters at his monthly news conference after the decision, said the rate moves were warranted by a further weakening of the euro-zone economy. In particular, he noted that the downturn has become more widespread, hitting even the region's strongest countries.

"We can genuinely say that this measure is addressed to the whole of the euro area, and not only specific countries," he said.

Earlier, the Bank of England's Monetary Policy Committee voted in London to boost its asset purchases by 50 billion pounds ($78.1 billion), bringing the total size of the program to £375 billion. The bank said it expected the purchases to take four months to complete.

The euro (EURUSD) tumbled 1.2% versus the dollar on the day to change hands at $1.2372, down from $1.2511 ahead of the ECB announcement. The British pound (GBPUSD) traded at $1.5505 versus the dollar, down 0.5% from Wednesday and off from $1.5566 ahead of the BOE and Chinese central-bank announcements.

The ECB's decision to cut its key lending rate and the Bank of England's quantitative-easing move were both widely expected.

The ECB, however, surprised investors somewhat with its decision to cut the deposit rate to zero. Several economists had forecast the ECB would hold the rate steady or to at least hold it above zero, fearing a more aggressive cut could hurt bank profits and weigh on already-weak private-sector lending.

Draghi, however, said the ECB's rate moves were decided unanimously by its governing council.

The ECB clearly hopes the move will spur banks that have been parking money overnight at the central bank to begin lending, economists said.

"What will matter in the coming days is how deposits at the ECB react (beyond the end of the reserve period on Tuesday next week), together with [money] market rates (such as EONIA), because it's here that the first indications will be as to whether the new policy is working in the monetary engine room," said Simon Smith, chief economist at FxPro in London.

Draghi said it remained too early to judge the impact on private-sector lending of the ECB's massive injections of liquidity into the region's financial system via a pair of three-year, long-term refinancing operations, or LTROs, in December and February, due in part to weak credit demand.

Draghi said policy makers didn't discuss implementing another LTRO or other so-called nonstandard measures on Thursday. Draghi said that was because the effectiveness of the bank's monetary-policy transmission channel varied across the region.

The ECB chief said the size of the Europe's rescue funds are currently adequate to meet possible "contingencies" and dismissed the notion of granting a banking license to the European Stability Mechanism, the region's permanent rescue fund, which would allow it to tap the ECB for additional funds.

"There is nothing to be gained by destroying the credibility of an institution by asking it to behave outside the limits of its mandate," he said.

The Bank of England, in a brief statement accompanying its rate announcement, focused on a deteriorating economic picture.

"U.K. output has barely grown for a year and a half and is estimated to have fallen in both of the past two quarters. The pace of expansion in most of the United Kingdom's main export markets also appears to have slowed. Business indicators point to a continuation of that weakness in the near term, both at home and abroad," the bank said in a statement accompanying the decision.

The central bank said policy makers welcomed the U.K. Treasury's recently announced "funding for lending" program but warned that continuing tight credit conditions and fiscal consolidation meant that inflation was likely to undershoot the bank's 2% annual target without additional monetary stimulus.

The MPC also left the bank's main lending rate unchanged at a record-low 0.5%, where it's stood since March 2009.

While the ECB has yet to join the Bank of England, Federal Reserve and Bank of Japan in conducting outright quantitative easing, the cut takes the central bank into uncharted territory.

The Bank of England first launched quantitative easing in March 2009. The central bank revived the dormant program last October, approving a round of purchases that took until May to complete.

The central bank then went back on hold, but minutes of its June meeting revealed just a 5-4 majority in favor of staying on the sidelines. A further deterioration in the economic outlook since that time was likely enough to spur Thursday's decision to approve a further round of purchases, economists said.

Howard Archer, chief U.K. economist at IHS Global Insight, said a weak June reading of the purchasing managers index was particularly likely to have moved MPC members to act. Surveys pointed to further contractions in activity in the manufacturing and construction sector, while services eked out only modest growth.

Overall, the readings pointed to the risk of a further contraction in gross domestic product in the second quarter, he noted. At the same time, inflation continues to fall, while oil prices are in retreat, blunting a concern that could potentially have stood in the way of action, economists said.

"The oil price fell by about 20% during [the second quarter of the year], and this, together with the government's announcement of a postponement of the rise in fuel duty planned for August, has led us to mark down significantly our inflation forecast for the remainder of this year. We now expect inflation to return to target in [the second half], a more rapid decline than the Bank of England had forecast in its May Inflation Report," said Simon Hayes, U.K. economist at Barclays.

The ECB moved as survey data showed the region's slowdown pushing into the euro zone's core, including Germany.

"With the euro zone's debt crisis intensifying again and the economic downturn deepening and broadening, we agree with the consensus view that the ECB will cut interest rates by 25 basis points today," wrote strategists at Capital Economics in London in advance of the central-bank announcements. "But the bank seems unlikely to announce more long-term lending, believing that the financial system as a whole has enough liquidity."