Markets fall after inaction on euro

The UK was facing more economic uncertainty tonight after the European Central Bank failed to deliver measures for tackling the region's debt crisis.

Markets fell sharply as ECB president Mario Draghi dashed hopes that he would signal an imminent move into bond markets to ease Spain's borrowing costs.

Uncertainty over the future of the euro has already deepened the UK's double-dip recession, with output down 0.7 per cent in the second quarter of 2012.

The ECB also kept its main interest rate on hold at 0.75 per cent, capping a week of inactivity from policymakers after the US Federal Reserve and the Bank of England opted to sit on their hands.

The Bank's monetary policy committee (MPC) is hoping that existing measures such as last month's additional £50 billion of quantitative easing and this week's launch of a “Funding for Lending” scheme will revive the economy.

The MPC, which concluded its latest meeting today under the chairmanship of Bank governor Sir Mervyn King, has also considered cutting rates below the current level of 0.5 per cent in a move that once seemed improbable.

Hopes that the ECB would introduce new measures today were stoked a week ago when Mr Draghi told an audience in London that he would do whatever it takes to save the euro. Many expected the bank at the very least to resume its bond-buying programme to keep a lid on Spain and Italy's borrowing costs.

He offered some hope today by saying that the ECB stood ready to intervene in bond markets, insisting that the euro currency was irreversible, but investors had hoped for actions rather than words.

The FTSE 100 Index lost earlier gains to stand 0.5 per cent lower at one stage, while the stock market tumbles were even more pronounced in Europe, where Germany's Dax and France's Cac-40 were down by more than 1 per cent.

The euro fell on currency markets, while Spain's borrowing costs, which had dropped in recent days, pushed back up to the 7 per cent danger mark.

CMC Markets analyst Colin Cieszynski said: “Today's announcement appears likely to destroy any remaining hopes that the crisis can be resolved in the near term.

”With stock markets moving into their weakest two months of the year and no significant developments scheduled until the very end of the month, markets could spend much of August under pressure again.“

Today's inaction suggests there remains a discord between policymakers on future measures, with Mr Draghi acknowledging the Bundesbank's opposition to bond buying.

Craig Erlam, market analyst for Alpari UK, said: ”Draghi looked like a man defeated in the press conference, which came shortly after his meeting with Jens Weidmann, head of the Bundesbank. Today's conference really has shown who is king.“

Meanwhile, the Bank of England has continued to favour quantitative easing as its economic weapon of choice.

But with the economy's second-quarter decline meaning the UK is now mired in the longest double-dip recession since quarterly records began in 1955 - and possibly since the Second World War - economists think the Bank will have to take further action before the end of the year.

Anna Leach, the CBI's head of economic analysis, said: ”With the latest extension of QE launched only last month, there was no great expectation for any new announcements from the MPC today.

“The Funding for Lending scheme is now up and running which, alongside the current round of asset purchases, should provide some support to businesses.

”However, the outlook for the UK economy remains fragile, particularly in light of the disappointing official data for the first half of the year and the recent slowdown in global momentum.“

The Bank's main concern over a rate cut beyond 0.5 per cent is the impact it could have on some banks' and building societies' ability to lend.

Lenders have assets, mainly mortgages, with interest payments contractually linked to the Bank's rate and a reduction below 0.5 per cent might squeeze some lenders' interest margins to the point at which they become less able to offer new loans to customers.

In its July meeting, the Bank raised the notion that the new £80 billion ”Funding for Lending“ scheme aimed at kick-starting bank lending could lessen fears about the impact of a rate cut on the margins of lenders.

PA