The European Central Bank slashed interest rates to a historic low of 0.25 per cent yesterday as Frankfurt policymakers reacted with unexpected force to the prospect of deflation gripping the single currency bloc.
The decision from the ECB's governing council to reduce its benchmark lending rate by a further 25 basis points caught financial markets off guard despite the fact that annual consumer price inflation dipped to just 0.7 per cent across the eurozone last month.
At a press conference, ECB president Mario Draghi forecast a "prolonged period of low inflation" for the eurozone. He revealed that the rate cut had not been unanimous, but added that the council had been "wholly in agreement of the need to act".
Most economists had expected no rate cut to be announced by the traditionally conservative Frankfurt-based central bank.
"Deflationary risks and the stronger euro seem to have motivated the ECB's move," said Carsten Brzeski of ING. "It is obvious that the ECB under Mario Draghi has become much more pro-active than under any of his predecessors."
The unexpected cut sent the euro tumbling by around 1.4 per cent against the dollar to $1.3378. The 17-member currency bloc emerged from recession earlier this year after six successive quarters of contraction. But the zone's unemployment rate remains high at 12.2 per cent, with joblessness in Spain and Greece above 25 per cent. The latest dip in the inflation rate to less than half the ECB's 2 per cent target provoked fears of an epidemic of falling prices that could mire the eurozone in stagnation.
"The low rates of inflation leave the single currency area vulnerable to a deflationary episode in the case of a negative demand shock and this is a risk the central bank simply cannot ignore," said Nick Kounis of ABN Amro.
The Bank of England kept its money stimulus programme and interest rates on hold yesterday, as it prepares to overhaul its growth and inflation forecasts next week. Under its forward guidance policy, it has pledged to lock interest rates on hold until unemployment falls to at least 7 per cent, which it forecast in August would not occur until 2016.
But recent stronger-than-expected GDP growth has prompted City traders to expect more rapid gains in employment and to price in a Bank rate rise in early 2015. Next Wednesday the Bank will publish its November Inflation Report, which economists are expecting to reveal higher growth forecasts and a more rapidly falling jobless rate. The jobless rate stands at 7.7 per cent, having declined from 7.8 per cent when the Bank unveiled forward guidance three months ago. The official July-September jobless rate will also be released next Wednesday.
Europe by numbers
0.7% eurozone inflation in October.
12.2% eurozone unemployment in September.