The European Central Bank cut interest rates for the first time in 10 months on Thursday and held out the possibility of further policy action to support the recession-hit euro zone economy.
Responding to a drop in euro zone inflation well below its target level and rising unemployment, the ECB lowered its main rate by a quarter percentage point to a record low 0.50 percent.
The ECB was also “technically ready” to cut its deposit rate from the current zero percent into negative territory, meaning it would start charging banks for holding their money overnight.
Such a move could encourage the banks to lend out money rather than hold it at the ECB, though it would also probably have a big impact on banks’ own operations and major implications for funding and bond markets.
The sudden slump in price pressures has also raised the possibility of the ECB having to look at policy tools beyond interest rates to counter any further slide in inflation.
“Ultimately, we think the ECB will have to purchase private-sector assets in order to fix the transmission mechanism,” said Andrew Bosomworth at PIMCO, the world’s largest bond fund.
Such asset purchases could take the ECB into the realm of quantitative easing (QE) – creating money to buy assets, a policy it has so far eschewed but which other major central banks have embraced.
The ECB wants to revive an asset class that has widely been blamed for causing the financial crisis – asset-backed securities (ABS).
This asset class allows banks to pass at least some of the credit risk on to other investors as they try to boost their capital and liquidity buffers to adapt to new regulatory standards – one reason for their reluctance to lend.