Draghi takes steps to prevent deflation

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Frankfurt and London - Mario Draghi unveiled an unprecedented round of measures to help the European Central Bank’s (ECB’s) record-low interest rates feed through to an economy threatened by deflation.

The ECB cut its deposit rate to minus 0.1 percent yesterday, becoming the first major central bank to take one of its main rates negative.

Draghi, the bank’s president, said it would introduce new, “targeted” offerings of liquidity to banks to encourage them to lend money to the real economy. Officials would also start work on purchases of asset-backed securities, he said.

“We decided on a combination of measures to provide additional monetary policy accommodation and to support lending to the real economy.”

A worsening in the economic outlook and a spell of slow inflation prompted the ECB to act to preserve the fragile recovery in the 18-nation currency bloc.

The ECB’s loose monetary policy has not been able to reach all parts of the bloc’s economy. While sovereign bond yields in Spain and Italy are near record lows, bank lending there is still contracting as the economy struggles to recover.

The euro fell as much as 0.3 percent to $1.3558 (R14.5843) in the immediate aftermath of the rate announcement. It has dropped 3 percent since touching a two-and-a-half-year high of nearly $1.40 on May 8.

The ECB would extend its offerings of unlimited cash to banks and suspend the sterilisation of its bond purchases at the start of the euro crisis in a bid to boost liquidity in money markets, Draghi said.

The benchmark refinancing rate was cut by 10 basis points and the marginal rate reduced by 35 basis points to 0.4 percent.

Introducing a charge for banks that want to deposit excess funds with the ECB has been heralded by Draghi as a way to stem unwanted increases in money-market rates, and curb the euro’s rise, which is adding to slower inflation.

Negative deposit rates have been used by a few smaller central banks in recent years, including Sweden’s, which conducted a 14-month experiment in 2009 and 2010. Denmark moved below zero in July 2012, though the cut was aimed more at protecting its currency than stimulating growth. It ended the policy in April.

Meanwhile, the Bank of England (BoE) stuck to its plan to nurse the economy back to health with record low interest rates yesterday, despite a strong recovery and fast-rising house prices which could lead to a split among policymakers.

Its monetary policy committee (MPC) left its benchmark interest rate at 0.5 percent, where it has sat since the worst of the financial crisis more than five years ago. It made no statement after a decision that had been widely expected. Details of how its nine members voted will be released shortly.

Martin Weale, the MPC member most likely to break ranks and cast a first vote for a rate hike, said borrowing costs should go up sooner rather than later although it was not time to start easing the economy off the BoE’s stimulus. - Bloomberg and Reuters


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