For the first time in its ten-year history, the European Central Bank (ECB) slashed interest rates on Thursday by three quarters of a percentage point. The cut, which reduces euro zone interest rates to just 2.5 percent, comes on the heels of two half-point cuts already carried out in November and October.
The stark reduction, which was greater than most analysts had predicted, shows the the ECB is serious about fighting the financial crisis, which has plunged Europe into a recession. Lower interest rates tend to stimulate the economy by loosening credit markets and making borrowing cheaper. Ever since the New York investment bank Lehman Brothers filed for bankruptcy on Sept. 15, credit markets have been extremely reluctant to take on any additional risk, making it virtually impossible for many companies to secure loans.
Although most economists had predicted only a half-point cut from the ECB, not all were surprised that the central bankers decided to take such drastic action. "Given how weak the economic data has been, the rate cuts are not so surprising," said Rainer Sartoris, an economist at HSBC Trinkaus, in an interview with Reuters. "They needed to have rates come down more quickly than before."
Central banks in the UK and in Sweden announced even greater rate cuts, stealing some of the ECB's thunder. Rainer Guntermann, an economist at Dresdner Kleinwort told Reuters that the ECB's cut, although the greatest in its history, is less impressive when compared to the action taken in Stockholm and London. "They clearly have an even more dramatic assessment of global conditions," he said.
British central bankers cut their rate by a full percentage point to just two percent, leaving rates at their lowest levels since 1939. Many observers expect British rates to decline by another full point next year as bankers try to head off a nasty recession. One central banker, Willem Buiter, has even pleaded for a zero interest rate policy to add a jolt of liquidity to the market.
In Sweden, rates plunged 175 basis points from 3.75 to 2 percent, causing the Swedish Krone to decline significantly in value. Although the cut was unexpectedly large, it isn't the biggest in its history. To be sure, the Swedish "Riksbank" has seen its shares of ups and downs: founded in 1668, it is by far the world's oldest central bank.
The cuts come on the same day that French President Nicolas Sarkozy announced that country's largest stimulus package since 1981, when France's only socialist president, Francois Mitterand, came to power. Sarkozy's plan, which includes a massive bailout of the French auto industry, comes with a price tag of €26 billion ($32.8 billion). Some €10 billion of the total will be used for massive infrastructure investments for high-speed rail lines, schools, and IT investments.
The package will result in a 2009 deficit that will equal 4 percent of France's gross domestic product. Euro-zone rules call for deficits not to exceed 3 percent of GDP, but allow for exceptions in crises. "We don't have a choice," Sarkozy said. "Doing nothing would be much more expensive."
cpg -- with wire reports