European Central Bank cuts interest rates just when everybody had decided it would do nothing

11/03/2011 10:40 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Surprise!

Just when everybody assumed that the European Central Bank would do nothing, the bank cut interest rates by 0.25 percentage points at new President Mario Draghi’s first meeting today. The cut brings the bank’s benchmark interest rate down to 1.25%. Only four of the 55 economists surveyed by Bloomberg before the meeting had predicted a rate cut.

The thinking was that with inflation climbing to an annual rate of 3% in October, well above the bank’s target of close to but below 2%, Draghi would be reluctant to move at his first meeting.

But in the days before the bank’s board of governors met in Frankfurt, data had increasingly pointed to a deepening of the current crisis. Yields on the Italian government’s 10-year bonds had jumped to 6.39%, a record for the euro era. (After the bank’s decision yields on the Italian 10-year note fell to 6.14%.) Unemployment in Germany climbed in October for the first time in two years and indexes showed manufacturing in Europe contracting for the third month in a row. The EuroZone looked increasingly like it was headed for a recession: On October 31 the Organization for Economic Cooperation and Development cut its forecast for growth in the region to just 0.3% in 2012. (Growth will come in at 1.6% for all of 2011, the group projected.)

And, of course, in the background there’s the little matter of the proposed Greek referendum on the recently announced grand plan to end the euro crisis. Overnight EuroZone leaders had warned that they would treat the vote, if it were held, as a referendum on Greek membership in the euro.

The next act for Draghi and the bank is today’s post-meeting press conference in Frankfurt, which started at 9:30 a.m. New York time. In his prepared remarks Draghi didn’t directly address the bank’s willingness to extend its current program of buying Greek, Spanish, and especially Italian debt in the market in order to support prices and drive down yields. The European Central Bank has already purchased $240 billion in bonds and there’s opposition at the bank and from some EuroZone governments (Germany, for example) to further expansion of the central bank’s balance sheet. Markets had been hoping that Draghi today might commit the bank to continue its current course or give some guidance on how far bank support might extend.

So far I haven’t heard that from the press conference. I guess Draghi’s boldness does have a limit. But markets are still up in the United States and Europe on this unexpected instance of decisive action from the EuroZone. As of 10:20 a.m. New York time the Standard & Poor’s 500 was up 0.3% and the German DAX index was up 1.1%.

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