In a bid to spur growth and avert the dangerous threat of deflation bedeviling the sluggish eurozone economy, the European Central Bank cut its benchmark interest rate to a record low and took the unprecedented step of lowering the bank deposit rate below zero.
The move, announced Thursday in Frankfurt, Germany, marks the first time that a major central bank has pushed down a key rate into negative territory. Not even the Bank of Japan, during its two-decade-long battle with deflation, or the Federal Reserve in the wake of the Great Recession, have tried such a radical approach.
By lowering the overnight bank deposit rate to negative 0.1 percent – from zero – the ECB will essentially be charging lenders to park their funds with the central bank. The hope is that it would prompt banks to boost their lending and also weaken the euro, helping to lift inflation.
The ECB’s benchmark interest rate was cut to 0.15 percent from a historical low of 0.25 percent. This was among other steps that ECB President Mario Draghi outlined Thursday to support bank lending.
The market reaction to the announcement was swift: Europe’s stock markets rose and the euro fell against the dollar to its lowest level since February.
Although it’s uncertain what the longer-term effect will be, analysts were widely expecting the ECB action after the eurozone reported that its inflation rate dropped to a four-year low of 0.5 percent in May. Fears of deflation, or falling prices, have increased amid persistently high unemployment and constrained government budgets, particularly in the eurozone’s periphery.
While falling prices may at first seem like a good thing, deflation cuts into business profits, raises real debt burdens and discourages consumer purchases, leading to pressure on investments and jobs.
The strong euro has not helped because it has dampened inflation by lowering import prices while also making Europe’s exports more expensive in foreign markets.