Borrowers across the struggling eurozone economies received an unexpected fillip on Thursday when the European Central Bank cut interest rates to a fresh record low, in a bid to stave off a slide into deflation.
After its monthly policy meeting in Frankfurt, the ECB's governing council announced that it would reduce its key refinancing rate to 0.25%, from 0.5%. While the economy of the 18-member single currency area clambered out of recession earlier this year, Mario Draghi, the ECB's president, warned that the outlook could deteriorate in the coming months. "The risks surrounding the economic outlook for the euro area continue to be on the downside," he said. "Developments in global money and financial market conditions and related uncertainties may have the potential to negatively affect economic conditions. Other downside risks include higher commodity prices, weaker than expected domestic demand and export growth, and slow or insufficient implementation of structural reforms in euro area countries." As well as the rate cut, which took financial markets by surprise, Draghi said the ECB would continue making low-cost loans to eurozone banks until at least mid-2015, to try to prevent the financial sector from seizing up.
Howard Archer, of consultancy IHS Global Insight, said: "The fact that the ECB chose to act now rather than wait until December when the governing council will have the ECB staff's new eurozone GDP and consumer price inflation forecasts suggests that the bank felt there was a compelling case for prompt action."
With inflation running well below the ECB's 2% target, at just 0.7% in October, a growing number of analysts have started to warn that deflation – which can be disastrous for economies carrying a heavy debt burden, as prices and wages fall while debt-levels remain fixed – is a real threat. Draghi suggested at his press conference that, "we may experience a prolonged period of low inflation".
1 comment:
It's true that exiting QE is quite challenging because no-one really knows how it's meant to work or what will happen. But there is the default option of doing nothing and waiting for the gilts to mature. As far as I can see from this spreadsheet of their total holdings (£334bn) about £28bn (9%) will mature by the end of 2014 and a further £24bn (7%) in 2015.
The Eurozone is clearly in a terrible mess but the UK economy seems to be doing rather well - and if unemployment is below 7% by the end of next year, as seems quite likely, then it will be a great achievement (given that we have about 1M people working here from the Eurozone) and not a cause for concern.
A rise in Base Rate to 0.75% would only make a small difference to mortgage repayments. On a 20 year £200k mortgage with an interest rate of 2% which is fairly typical going to 2.25% the monthly repayments go from about £1019 to about £1044 so just £25 (or about 2.4%) which won't really make any difference. This is not as scary as people think.
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