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Surprise! ECB Cuts Rates and Initiates Bond-Buying Program

mario draghi

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In a surprise move, the ECB has cut key interest rates in the Eurozone. In an effort to fight deflation and boost economic activity, all of the bank's interest rates were lowered on Thursday to new record lows and rates on bank deposits moved further into negative territory.

The ECB's primary lending rate was cut to 0.05% from 0.15%. The central bank also cut the rate it charges on overnight loans to 0.30% from 0.40%. Finally, the central bank lowered rates on overnight deposits at the central bank to -0.2% from -0.1%. Recall that in June, the ECB became the largest central bank to experiment with a negative rate on bank deposits, a measure aimed at encouraging banks to lend surplus funds to other financial institutions rather than parking them at the ECB.

ECB President Draghi apparently made good on the hints he made at the Fed's symposium in Jackson Hole – although most economists had expected no change from the ECB meeting.

Draghi also announced that the bank will begin a bond-buying program. The bank will begin buying ABS (asset backed securities) and covered bonds in October and will support "forward guidance" in terms of its monetary policy.

Draghi says the decision regarding the use of additional non-standard tools if needed was unanimous.

The ECB President also said the council considered subdued inflation outlook and weakening growth as part of the decision and that buying ABS will have a sizeable impact on balance sheets and that the overall goal is to bring inflation closer to 2%.

The ECB's decision was apparently triggerd by falling inflation expectations and weakening economic data. The ECB staff cut its 2014 growth forecast to 0.9% in 2014 from the June forecast at 1%. The 2015 growth rate was cut to 1.5% from 1.7% and 2016's outlook was increased to 1.9% vs. 1.8%.

On the inflation front, the ECB staff cut its 2014 forecast to 0.6% from 0.7% in June, while 2015 and 2016 forecast are unchanged at 1.1%, respectively.

During the press conference, Draghi said that there has been a “worsening” of the medium-term inflation outlook, with a downward movement in all indicators of inflation expectations.

“The growth recovery was losing momentum, so the Governing Council decided to a great extent to strengthen the measures taken in June. In this sense, the ABS outright purchases could be viewed as a measure to strengthen the TLTRO,” Draghi says.

A separate report showed inflation had fallen to a five-year low in August, just 0.3% on a year-over-year basis, which is far below the ECB's target of a little under 2%

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About the Author

David Moenning is the Chief Investment Officer at Sowell Management Services. Dave began his investment career in 1980 and has been an independent money manager since 1987. Thus, Dave has been live on the firing line and investing for a living for more than 29 years.