ECB cuts key rate to record low 0.5% as focus shifts to growth from austerity

BRATISLAVA (AFP, REUTERS) - The European Central Bank (ECB) pared back its key interest rates on Thursday, as calls mount across the euro zone to focus on growth rather than austerity.

As widely forecast by analysts, the ECB trimmed its central "refi" refinancing rate by a quarter of a percentage point to a new record low of 0.5 per cent.

The move comes amid fears the euro zone economy may not recover later in the year from its recession. In theory, a cut helps companies by lowering borrowing costs for banks that have borrowed from the ECB so they could loan more. It also signals the ECB's willingness to support the economy.

Economists, however, warn this cut may not have much direct effect since banks are not passing on low rates in indebted countries that need help the most.

The cut was widely expected, after ECB president Mario Draghi said last month the bank stood ready to act.

Economic data over the last month have bolstered the case for action, with unemployment hitting a record high last month, when inflation saw its biggest monthly drop in over four years, to 1.2 per cent.

"The ECB is playing it safe, even though they know the effect is likely to be limited," Nordea analyst Anders Svendsen said of the cut. "The key for the market is the tone. If the ECB comes out with other measures as well to help SME (small and mid-sized enterprise) lending that will be positive, but if they say the cut was all they had, I think there will be disappointment."

The sharp drop in inflation, from 1.7 per cent in March pressured the ECB to cut rates to honour its mandate to deliver price stability, which it defines as inflation close to but below 2 per cent.

The sudden slump in price pressures has also raised the possibility of the ECB having to look at policy tools beyond interest rates to counter any further slide in inflation.

"Ultimately, we think the ECB will have to purchase private-sector assets in order to fix the transmission mechanism," said Mr Andrew Bosomworth at Pimco, the world's largest bond fund.

The ECB wants to improve the transmission of its monetary policy so its low rates reach all corners of the euro zone.

The bloc's south is not benefiting to the same extent as the north from the ultra-low rates. If they are lending at all, banks there are charging companies and households more for loans than their peers in the north because of higher funding costs and credit risks.