November 7, 2013
European Central Bank Makes a Surprise Rate Cut
By JACK EWING .
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Daniel Roland/Agence France-Presse — Getty Images
Mario Draghi, head of the European Central Bank, said on Thursday that interest rates would stay low for an extended period of time.
FRANKFURT — In an unexpectedly swift reaction to economic warning signals, the European Central Bank cut its benchmark interest rate to a record low on Thursday, moving to head off what some economists fear could be a long period of stagnation like the one that has afflicted Japan.
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The cut in the E.C.B.'s main rate to 0.25 percent from 0.5 percent took many analysts by surprise, and seemed intended to reinforce a vow last year by Mario Draghi, the bank’s president, to do “whatever it takes” to preserve the euro zone.
The central bank was reacting to a sudden drop in euro zone inflation, which fell to an annual rate of 0.7 percent in October, well below the bank’s official target of about 2 percent. The decline raised the specter of deflation, a sustained fall in prices that can destroy the profits of companies and the jobs they provide.
Mr. Draghi insisted that the E.C.B. was not expecting such a catastrophic situation. “If we mean by deflation a self-fulfilling fall in prices across a very large category of goods, and across a very significant number of countries, we don’t see that,” he said at a news conference. “I don’t think it is similar to Japan.”
But by moving sooner than expected, Mr. Draghi and the other 22 members of the E.C.B. Governing Council answered critics who have said they are too divisive and reluctant to stimulate the economy as forcefully as the United States Federal Reserve or the Bank of England, neither of which are accountable to a group of individual countries that often have differing economic agendas.
Within the sometimes fractious 17-nation euro currency union, the E.C.B. is the closest thing the euro zone has to a central policy-making agency, and Mr. Draghi has shown a willingness to have it play that role, limited though its powers may be. The rate cut was the first since May and the fifth since Mr. Draghi became the E.C.B.'s president in 2011.
“It was really important to challenge that perception that the E.C.B. is indifferent,” said Richard Barwell, an economist at Royal Bank of Scotland who was one of the few to predict a rate cut. “Within their remit, they are willing to do whatever it takes to save the euro.”
At the same time, some economists questioned how much the cut would achieve in the absence of any fiscal stimulus from euro zone governments. Countries like Italy and Spain cannot afford to increase government spending, while Germany, which can, is not willing to. That is one reason the euro zone economy is stuck in economic limbo, no longer in recession but barely growing.
“In the end it comes down to the E.C.B.,” said Zsolt Darvas, a senior fellow at Bruegel, a research organization in Brussels. “But the E.C.B.'s powers are limited.”
Predictably, the rate cut won praise from countries with weak economies — and drew criticism from Germany, which has a historical aversion to inflation and fears that looser money will lead to profligacy among the euro zone’s more financially troubled members.
Pierre Moscovici, the French finance minister, said in a Twitter message that the rate cut provided “welcome support for the ongoing recovery in the euro zone by limiting the risk of deflation.”
But a German banking group expressed dismay. “Unprecedented low interest rates substantially devalue savings in Germany and the euro area and increase the danger of bubbles,” the Association of German Public Banks said in a statement.
The view in Germany and among some economists is that there is no threat of deflation. This group sees slowing inflation merely as a sign that wages are falling in countries like Spain and Greece, where labor costs had become too high for companies to compete in the international marketplace.
Given those arguments against a rate cut now, Mr. Draghi showed on Thursday that he was willing to overrule German objections. It is likely that Jens Weidmann, president of the German central bank, was among members of the E.C.B. Governing Council who, according to Mr. Draghi, wanted to wait for more information before taking action. Mr. Draghi did not identify the dissenters, though, and the German central bank, the Bundesbank, declined to comment.
European stocks were mixed on the news, with exchanges in Paris and Frankfurt initially up more than 1 percent and then falling flat, while the euro fell more than 1 percent against the dollar. A cheaper euro makes European products less expensive abroad. Mr. Draghi denied that the E.C.B. was deliberately trying to drive down the euro.
The fall in the euro also reflected strong economic data from the United States, where the government said the economy grew at an annual rate of 2.8 percent in the third quarter, significantly better than economists had expected and the fastest pace this year.
Troubled by persistently slow growth and only gradual improvement in the labor market in the United States, the Federal Reserve has kept up its stimulus efforts more intently and for longer than many observers had expected as recently as this summer. The Fed has a dual mandate, promoting employment growth as well as price stability.
The E.C.B.'s prime mandate is to defend price stability, which also means intervening if inflation is too low. But most analysts had expected the E.C.B. to wait until December to act, once there was more economic data available.
“Deflationary risks and the stronger euro seem to have motivated the E.C.B.'s move,” Carsten Brzeski, an analyst at ING Bank, said in a note to clients. “It is obvious that the E.C.B. under President Draghi has become much more proactive than under any of his predecessors.”
The E.C.B. decision carries some risks. If the economy gets worse, the decision to cut to 0.25 percent leaves the bank with little additional room to maneuver.
Mr. Draghi repeated assurances on Thursday that rates would stay low for an extended period of time. The central bank will also keep supplying banks with cheap loans through mid-2015, he said, but he did not announce a new round of long-term three-year loans.
That is another contrast to the active stimulus tools at the disposal of the United States Fed and the British central bank. On Thursday, the Bank of England said it would continue its program of economic stimulus at 375 billion pounds, or about $600 billion. And unlike the E.C.B., the British bank on Thursday kept its benchmark interest rate unchanged, at a record low of 0.5 percent, amid signs that the country’s economic recovery was gaining speed and consumer confidence was improving.
Some economists have argued that falling inflation in the euro zone, coming after five years of recession or very slow growth, means that the currency bloc faces an acute risk of deflation. While lower prices might seem like a good thing for consumers, in fact deflation is considered even more dangerous than runaway inflation.
When prices fall, consumers and businesses delay purchases because they expect goods to become even cheaper. Corporate profits decline, and companies are forced to pay their workers less. A spiral begins that is difficult to brake.
When prices fall, consumers and businesses delay purchases because they expect goods to become even cheaper. Corporate profits decline, and companies are forced to pay their workers less. A spiral begins that is difficult to brake.
Deflation could be particularly destructive in Europe, where governments, banks and private households are still struggling with excess debt. When companies and individuals earn less, they have trouble repaying their debts, which remain the same.
There was still no sign from Mr. Draghi that the E.C.B. is considering the huge purchases of government bonds that the Fed and the Bank of England have used to stimulate growth after interest rates were already close to zero.
Although the euro zone emerged from recession earlier this year, recent economic indicators have sent conflicting signals about the strength of the recovery. Few economists expect a strong rebound, but some have been more pessimistic than others, warning of long-term stagnation if the E.C.B. does not do more to stimulate lending and growth.
“Will the rate cut help? I don’t think so,” Carl Weinberg, chief economist of High Frequency Economics in Valhalla, N.Y., said in an email. “Euroland’s economy is being strangled by a credit crunch. The real story is that the depression in Euroland is putting severe disinflationary pressure on prices. The forecast is for the downward pressure to get worse before it gets better.”
Nelson Schwartz contributed reporting from New York, and David Jolly from Paris.
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