Markets surprised as ECB cuts interest rate to record low

The European Central Bank cut its benchmark interest rate to a record low of 0.25 per cent yesterday, taking markets by surprise and providing a welcome boost to homeowners across the euro zone.

The move sent the euro to a seven-week low against the dollar, while euro zone government bond yields surged as the interest-rate cut boosted the demand for fixed-income assets.

In a boost to banks the refinance rate was also cut by a quarter of a percentage point to 0.75 per cent, while the deposit interest rate remains unchanged at 0 per cent.

Addressing journalists after the rate-setting decision, ECB president Mario Draghi hinted that further cuts could be on the table.

“We have a whole range of instrument to activate before reaching the lower bound... in principle we could even cut further the interest rate,” he said, adding that the current trend of low inflation would extend for “some period of time”.

The decision to cut rates was in line with the bank’s forward guidance in July, Mr Draghi said, in light of the further diminishing underlying price pressures in the euro area.

The ECB also committed to continue its offering of one-month and three-month cash until early July 2015, providing more liquidity to the banking system.

Asked whether the bank would consider quantitative easing, he said a number of options were available before quantitative easing would be considered.

Most analysts believe that the ECB is still unlikely to engage in quantitative easing despite the fact that its options are narrowing as interest rates approach close to zero.

Asked whether the recent strength of the euro was a factor in yesterday's decision, Mr Draghi said that exchange rates were "not a policy target" and played no role in the decision.

Pressure to act
The ECB had been under pressure to act at yesterday's rate-setting meeting following weak economic figures over the last few weeks, most notably a sharp drop in inflation in October. However, virtually all analysts had expected a decision to be postponed until next month.

Minister for Finance Michael Noonan welcomed the interest rate move. "We wanted interest rates to go down and it helps our position going back into the markets because the spreads in Europe should narrow now. The interest rate reduction and the suggestion that the currency level might go down a little would both help our exports and help our economy to grow."