ECB cuts key rate to new low to help economy

President of European Central Bank Mario Draghi  speaks during a press conference in Frankfurt, Germany, Thursday, July 5, 2012. The European Central Bank has cut its key interest rate by a quarter percentage point to a record low of 0.75 percent to boost a eurozone economy weighed down by the continent's crisis over too much government debt.  The move followed a rate cut by China's central bank and new stimulus measures by the Bank of England as global financial authorities seek to shore up a slowing global economy. European leaders last week agreed on new steps to strengthen market confidence in their shared euro currency bloc. They agreed to set up a single banking supervisor to keep bank bailouts from bankrupting countries and made it easier for troubled countries to get bailout help.  Those steps helped calm financial markets, which have expected the ECB to follow up with more help in the form of a rate cut  (AP Photo/Michael Probst)

President of European Central Bank Mario Draghi speaks during a press conference in Frankfurt, Germany, Thursday, July 5, 2012. The European Central Bank has cut its key interest rate by a quarter percentage point to a record low of 0.75 percent to boost a eurozone economy weighed down by the continent's crisis over too much government debt. The move followed a rate cut by China's central bank and new stimulus measures by the Bank of England as global financial authorities seek to shore up a slowing global economy. European leaders last week agreed on new steps to strengthen market confidence in their shared euro currency bloc. They agreed to set up a single banking supervisor to keep bank bailouts from bankrupting countries and made it easier for troubled countries to get bailout help. Those steps helped calm financial markets, which have expected the ECB to follow up with more help in the form of a rate cut (AP Photo/Michael Probst)

FRANKFURT, Germany (AP) — The European Central Bank cut its key interest rate by a quarter percentage point Thursday to a record low 0.75 percent to try to help ease Europe's financial crisis and boost its sagging economy.

The action, which was widely expected, is meant to make it cheaper for businesses and consumers to borrow and spend money.

In a more surprising move, the ECB cut the interest rate it pays banks on overnight deposits by a quarter percentage point — to zero. The goal is for banks to lend the money, rather than sock it away with the ECB.

ECB President Mario Draghi said the eurozone economy would recover only gradually and that risks "continue to be on the downside." He said that some of the risks foreseen from the debt crisis had already materialized, pushing the bank to act.

Analysts warned the rate cuts might do little to jolt the eurozone economy back to life. Borrowing rates are already low, but businesses and households are not spending money because they are afraid of the economic outlook.

Draghi conceded the cut sent a "muted" signal given weak demand for credit. But he said the move was an important signal of encouragement for businesses during a time of uncertainty. "It should make entrepreneurs think that their investment decisions and tradeoffs are now improved," he said.

Stock markets initially rose after the news, but the gains faded as investors worried about a slowdown in the global economy. Germany's DAX stock index fell 0.8 percent and the Dow 0.3 percent. The euro was down 1.1 percent at $1.2380.

Draghi said the ECB was free to cut rates because inflation was expected to fall. The ECB has a strict mandate to fight inflation as its first priority, unlike the U.S. Federal Reserve which can juggle concerns about inflation against the need to make the economy grow and create jobs.

"Today's ECB interest rate cut does little to alter the bleak economic outlook," said Jennifer McKeown, analyst at Capital Economics.

She said the ECB is likely to now wait and see how the financial markets and the economy react to the rate cut and to the new emergency measures announced by European leaders last week.

The leaders agreed to make it easier for troubled countries and banks to receive rescue loans from Europe's bailout fund and also signaled greater willingness to use emergency funds to purchase government bonds. The goal would be to drive down troubled countries' borrowing costs. They also agreed to create a single Europe-wide banking regulator to prevent bank bailouts from wrecking individual countries' government finances.

Collectively, the moves sent a message to financial markets that leaders from the 17 countries that use the euro could work together to fix their problems. They also helped lower the high borrowing costs for financially stressed countries such as Italy and Spain, the euro region's third- and fourth-largest economies.

Lending activity in the eurozone has remained weak because businesses are not asking for credit because of the slow economy and out of fear that the eurozone may suffer a further financial calamity. Concerns remain that bankrupt Greece could eventually leave the euro, causing more turmoil, or that Spain and Italy could need bailouts that would strain the resources of donor countries.

Joerg Kraemer, chief economist at Commerzbank, said the cut wouldn't fix what was wrong. The reason the eurozone economy is weak is not because of "high ECB rates but because of uncertainty stemming from the sovereign debt crisis. This can't be cured by lower rates."

The rate cut will give some further relief to banks by cutting the rate they pay on the €1 trillion in cheap emergency loans they took from the ECB Dec. 21 and Feb. 29. The rate on that money is the average refinancing rate over the life of the loan, which can be up to three years. Lower costs on that money means they can earn more when they use it to buy higher yielding investments such as government bonds. That in turn can help government's ability to borrow more cheaply, but also means trouble can spread faster from government to banks or vice versa.

The economy in the 17 countries that use the euro is expected to shrink by a relatively mild 0.3 percent according to EU predictions. But recent data indicate the downturn could be worse. Business sentiment is dropping even in Germany, Europe's biggest and strongest economy.

A bigger drop in eurozone output would make it harder for indebted countries to pay off maturing debt and convince bond investors to keep lending them money. Debts get larger compared to the size of the economy as output shrinks, while growth reduces the relative size of debt and increases tax revenues governments can use to meet their obligation.

The 2 ½ year old eurozone crisis has seen Greece, Ireland and Portugal need bailouts from the other eurozone countries and the International Monetary Fund to keep paying their debts and covering ther budget deficits. Spain has asked for as much as €100 billion in rescue loans for its banks.

Earlier in the day, the central banks of China and Britain took action to stimulate their economies.

The Bank of England decided to purchase another 50 billion pounds in government bonds from financial institutions. The hope is that the banks will use the extra cash to lend to businesses and households.

China's central bank, meanwhile, cut interest rates for the second time in a month to shore up its economy, the second-largest in the world. Interest on a one-year loan was reduced by 0.31 percentage points to 6 percent effective Friday. Chinese authorities have rolled out a series of stimulus measures since March after economic growth slowed to a nearly three-year low of 8.1 percent in the first quarter.

In the U.S., weak economic indicators have raised speculation that the U.S. Federal Reserve may also have to do more to keep the U.S. economy growing. Some think the Fed might carry out a third round of bond purchases aimed at driving down interest rates on business and consumer loans.

The Fed took more limited action at its meeting ending June 17, extending its so-called Operation Twist effort in which it sells short-term bonds and buys longer-dated issues to push down long term interest rates. The Fed meets next Aug. 1.

Associated Press
Copyright 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.


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