ECB cuts interest rates to new low of 1.25%

The European Central Bank (ECB) surprised financial markets today by cutting its main interest rate by a smaller-than-expected 25 basis points, taking it to a new low of 1.25 per cent.

While the move will result in monthly repayments on many typical mortgages falling by between €25 to €65, it has disappointed analysts who had hoped for a half-point reduction.

It also lowered its overnight deposit rate - the rate currently setting the floor in money markets - by 25 points, taking this down to just 0.25 per cent.

A number of mortgage lenders have already announced plans to pass the reduction on to customers.

Halifax and Bank of Scotland (Ireland) said they will pass the full reduction to all holders of a variable rate mortgage, as did EBS.

The State's largest mortgage lender Permanent tsb and AIB have decided to pass on the rate cut to all owner-occupiers but not for mortgages secured against investment properties or holiday homes.

Bank of Ireland and ICS Building Society said they will pass on the full ECB rate decrease across Tracker, Standard Variable Rate and Variable LTV based mortgage products.

The rate cut will result in a further saving of about €40 per month for the holders of a €300,000 mortgage over 30 years, based on a tracker mortgage with a margin of 1.3 percentage points over the ECB rate.

Monthly repayments on a mortgage of this type have fallen by approximately €520 since October 2008, when the ECB began this series of interest rate cuts.

This is the sixth interest cut by the ECB since last October as it tries to stimulate the euro zone economy.

During this process the ECB has taken its key lending rate from 4.25 per cent to 1.25 per cent.

Holders of a tracker rate mortgage will automatically receive the reduction from all lenders although the banks have discretion with regards to passing on the rate cut to variable rate mortgage holders.

The euro extended gains against the dollar on the decision and euro zone government bonds and interest rate futures extended losses, with the yield on interest-rate sensitive two-year government bonds rising to a near one-week high.

"This was a surprise, it seems like a compromise and left expectations of a further rate cut still alive," said Dresdner Kleinwort economist Rainer Guntermann. "It was a disappointment that the ECB Governing Council did not find a more decisive reaction."

Others were also taken aback. "It sends the signal that they don't mean business and continue to be behind the curve," said Philippe Gijsels, strategist at Fortis in Brussels. "A cut of only 25 basis points indicates that there is not much urgency."

The latest economic data have shown little sign of a let up in the recession, while annual inflation hit a record low of 0.6 per cent in March and is expected to fall further.

Euro zone unemployment jumped more than expected in February to 8.5 per cent, while the Organisation for Economic Cooperation and Development warned this week it could reach almost 12 per cent in 2010.

The OECD also predicted the economy would shrink 4.1 per cent this year, far more that the ECB's current worst case scenario of 3.2 per cent, and lending data now show banks are reducing the supply of loans to firms and consumers.

Additional reporting Reuters