Draghi cuts ECB rate to fight ‘prolonged’ inflation weakness

Deflation Spiral

That’s sparked fears that the economy could slip into a deflationary cycle, angst that was fueled when a report last week showed inflation unexpectedly slowed in October to 0.7 percent. That compares with an ECB target of “close to but below” 2 percent.

“There comes a point where inflation is so weak, and coming in weaker than anticipated, that the case for loosening policy becomes too hard to resist,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London, who predicted the cut. “Bad unemployment numbers only make the case stronger.”

Beyond rate cuts and further liquidity measures, more expansive actions may still be harder to countenance. A Federal Reserve-style quantitative easing program has repeatedly been ruled out by ECB policy makers. The central bank is barred by European Union treaties from financing state debt, making large- scale purchases of government bonds open to a legal challenge.

While Draghi again floated the prospect of a negative deposit rate, the rate for commercial lenders who park excess cash at the central bank, officials have said that its effects can’t be adequately predicted. 

Negative Rates

A negative deposit rate could hurt banks’ profitability by lowering money-market rates, potentially hampering credit supply to companies and households and reducing banks’ incentive to lend to other financial institutions.

Today’s decision aligns the ECB with other central banks in reinforcing rather than retracting loose monetary policy amid sluggish economic growth and soft inflation. The Fed decided in September not to taper its asset purchase program, while the Bank of Canada dropped language last month about the need for future rate increases. Emerging markets from Israel to Chile have cut borrowing costs since the start of September.

Taking Office

The unexpected nature of the rate cut underscores Draghi’s status as a central banker prepared to tackle head on the challenges facing the euro.

Since he took office almost exactly two years ago, Draghi has cut rates by a cumulative 1.25 percentage points, pumped unlimited quantities of three-year loans into the financial system and pledged to do “whatever it takes” to defend the euro. That announcement, in the teeth of criticism from some central bankerks in Europe, helped draw a line under the region’s debt crisis.

“I have a huge amount of respect for the Draghi regime,” said Kit Juckes, global strategist at Societe Generale SA in London. “He is incredibly imaginative and innovative, even if he isn’t armed with big enough weapons.”

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