European Central Bank cuts key interest rate to record 1%

Will implement $80-billion plan to buy bonds.

The European Central Bank (ECB) cut its key interest rate to a new record low of 1 per cent today. President Jean-Claude Trichet also said that the ECB unanimously agreed a ¤60-billion ($80 billion) plan to buy bonds as officials step up their response to the worst recession since World War II.

“The governing council has decided in principle that the eurosystem will purchase euro-denominated bonds issued in the euro area,” Trichet said at a press conference in Frankfurt.

ECB officials, meeting in Frankfurt, lowered the benchmark rate by a quarter point. Separately, the Bank of England left its key rate at 0.5 per cent and increased its asset-purchase programme.

Trichet said the ECB’s main interest rate is appropriate now and that the ECB will extend its unlimited auctions of funds to banks.

ECB officials have spent the past months bickering over whether to fight a recession by purchasing assets, with Bundesbank President Axel Weber leading resistance to such a move.

The US Federal Reserve, the Bank of England and the Bank of Japan have lowered rates close to zero and are already buying bonds, effectively printing money to reflate their economies in a policy known as quantitative easing.

“It’s a significant departure from previous ECB policy,” said Gilles Moec, senior economist at Bank of America-Merrill Lynch in London. “But other central banks have been a lot more aggressive.”

‘EU economy improving’
Trichet, who refused to exclude further rate cuts, also said there’s evidence that Europe’s economy is improving.

“The latest economic data suggest tentative signs of stabilisation at very low levels after a first quarter that was significantly weaker than expected,” Trichet said. “Inflationary pressure has been diminishing as money and credit growth have further decelerated.”

“That’s it with rates,” said Stephane Deo, chief European economist at UBS in London. “They are now moving into unconventional territory.”

Deflation threat
But the 16-nation economy may shrink 4.2 per cent this year, according to the International Monetary Fund, more than the projected 2.8 per cent contraction in the US and a 4.1 per cent slump in the UK.

While some economic reports are pointing to stabilisation, lending to companies and consumers dropped for a second straight month in March and a European Commission survey shows households expect prices to fall over the next 12 months.

Inflation was 0.6 per cent in April. The ECB, which aims to keep the rate just below 2 per cent, says it may dip below zero this summer.

“If inflation threatens to remain significantly below 2 per cent for a considerable period of time, then additional policy easing could be warranted after May,” Orphanides, a former Fed adviser, said in an April 14 interview.