FRANKFURT • The European Central Bank (ECB) yesterday cut the deposit rate to a historic low as it sought to fight stubbornly low inflation, testing the limits of monetary policy and hoping to bolster its credibility.
Making good on its promise to do what it must to boost inflation "as quickly as possible", the ECB lowered its deposit rate by 0.1 percentage point to -0.3 per cent, charging banks more for parking cash with the central bank.
The ECB has also adjusted its asset purchase programme, known as quantitative easing (QE), extending the scheme's duration into 2017 and agreeing to buy euro-denominated municipal and regional bonds, said ECB president Mario Draghi at a press conference yesterday.
Purchases of mainly government bonds - at €60 billion (S$89 billion) a month - are now seen running until at least March 2017 instead of next September. Mr Draghi also said proceeds from the various assets bought would be reinvested back into the scheme.
"We decided to extend the asset purchase programme. The monthly purchases... are now intended to run until the end of March 2017 or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation," he said.
Years of missing the inflation target has threatened the ECB's credibility and Mr Draghi said recently that if the new forecasts showed it could be missed again, the bank would do what it must to bring it back to target as quickly as possible.
The ECB now sees inflation at 1 per cent next year, below its September forecast of 1.1 per cent, and expects inflation of 1.6 per cent in 2017, again slightly lower than its previous 1.7 per cent projection.
Its inflation forecast for this year was unchanged at 0.1 per cent.
Markets, hoping for deeper rate reductions, reacted with disappointment to yesterday's announcement.
"What has been delivered is way short of market expectations," said Mr Alvin Tan, a London-based strategist at Societe Generale.
"The market needed at least 20 basis points to keep euro-dollar under pressure. Rather disappointing with the lack of an expansion of the QE programme."
The euro traded at US$1.0838 as of 1.43pm London time, the most since March 18, while European shares turned lower after the rate cut. The Stoxx Europe 600 Index was down 2.1 per cent as of 1.38pm London time, the most in two months. Euro-zone government bonds extended a drop.
United States stocks also looked set for a volatile start after the announcement.
Risk assets were already feeling bruised after Federal Reserve chairman Janet Yellen said on Wednesday that she was looking forward to raising US rates.
Dr Yellen, who warned of the risks of waiting too long before lift-off, was to speak in front of a congressional committee late yesterday.
"I'm a bit concerned about this Federal Reserve hike now that it is coming closer," said Mr Anders Svendsen, an analyst at Nordea Bank in Copenhagen.
"We are looking at a few more weeks of general emerging-market foreign-exchange weakness. Next year, the situation might start to look a bit better."
REUTERS, BLOOMBERG
