ECB interest rate cut stuns markets

Updated: 

Global Economy

The European Central Bank has stunned markets by slashing interest rates to a new low of 0.25% on worries over low inflation and persistent weak growth.

The ECB said its decision to cut its base rate from 0.5% was based on the likelihood that Europe faces a "prolonged period of low inflation".



The single currency slumped against sterling, with the pound surging to just over 1.20 euros - its highest level since January.

A weaker euro will help Europe's manufacturers but create a headache for Britain's exports to its biggest trading partner.

The ECB's decision follows European price rises easing sharply to 0.7% in October from 1.1% in September, slumping to a near four-year low, which is well below the central bank's target of keeping inflation just below 2%.

The cut contrasted with the Bank of England's noon decision to hold UK rates steady at 0.5%.

Markets across Europe surged, with the Dax in Germany up 0.8% and France's Cac 40 0.7% higher.

But the FTSE 100 Index in London lost initial gains after the decision, to stand 0.4% lower.

ECB president Mario Draghi said the rate reduction would "assist the gradual economic recovery".

He added: "The risks surrounding the economic outlook for the euro area continue to be on the downside.

"Developments in global money and financial market conditions and related uncertainties may have the potential to negatively affect economic conditions."

Experts said the threat of a damaging deflationary spiral - where falling prices depress growth - was clearly worrying European rate-setters.

Craig Erlam, market analyst at Alpari, said: " It's very rare that we see this kind of knee-jerk reaction from the ECB, so the threat of deflation is clearly very real."

Kathleen Brooks, research director at Forex.com, said it was a " shock decision" for markets.

"It appears that the ECB has taken the side of the weak peripheral (economies) who are suffering from signs of deflation, while the core has seen prices remain fairly stable in recent months," she said.

But Ishaq Siddiqi, m arket strategist at ETX Capital, questioned how effective the rate cut will be.

"It seems more of a demonstration by the ECB to move away from liquidity pumping measures to measures which will ensure sustainable growth feeding into the real economy," he said.

IHS Global Insight economist Howard Archer said the rate cut was "obviously the consequence of uncomfortably low and falling Eurozone consumer price inflation".

He added: "While it seems unlikely that an interest rate cut to 0.25% would have a major impact in boosting eurozone growth, it may at least help keep the euro at a more competitive level and limit market interest rates."