ECB announces combined new measures to fight downturns

Special Report: Global Financial Crisis

FRANKFURT, May 7 (Xinhua) -- The European Central Bank (ECB) on Thursday renewed its efforts to fight against economic downturns, with combined measures including cutting its key interest rate to a new low and buying up bonds, surprising most market players.

RATE CUT

The ECB cut its key interest rate by 25 basis points to a record-low 1 percent on Thursday.

ECB President Jean-Claude Trichet told reporters after the ratecut this was not necessarily the lowest point of the cycle, which has slashed the main refinancing rate by 325 basis points since October.

The ECB said the rate cut is due to the fact that the inflation threat to the eurozone continue easing, while the recession deepens.

According to the International Monetary Fund, the 16-nation economy will shrink 4.2 percent this year, more than the projected2.8 percent contraction in the United States and 4.1 percent in the United Kingdom.

Inflation was 0.6 percent in April. The ECB, which aims to keep the rate just below 2 percent, said the figure may drop below zero in 2009.

BUYING UP BONDS

Trichet announced the ECB plans to spend about 60 billion euros(80 billion U.S. dollars) buying covered bonds, taking markets by surprise after Bundesbank chief Axel Weber had campaigned against such a policy, though some smaller nations pushed it.

It marks the first step of the central bank of Europe on a path of quantitative easing, following the U.S. Federal Reserve, the Bank of England and the Japanese central bank.

Unlike its counterparts in the U.S., Britain and Japan, the ECB chose not to buy national bonds, because it was banned by EU laws from buying bonds of EU member countries.

Moreover, a consensus was hard to be achieved on the purchase proportion of the national bonds among the 16 EU members, the main players of the euro zone.

The ECB has "decided in principle to buy euro-denominated covered bonds issued by member countries of the euro zone," said Trichet, adding that "more details will be announced after the next June 4 meeting of the governing council."

The covered bonds, securities issued by banks and backed by mortgages or other loans, are regarded as the safest corporation bonds after the national debt, with its interest rate slightly higher than the national bonds.

Analysts said, with the euro zone banks accounting for nearly three quarters of business financing, expanding money supply to the banks through buying up bonds and providing longer term loans will help to further relax money market conditions with major relief to the banking system.

OTHER MEASURES

The ECB also announced Thursday the extension of unlimited cash loans to commercial banks for up to 12 months from the current maximum of six, with the exact interest rate to be decided on June23.

But the commercial banks will not apply for long-term loans before they are assured that the key interest rate has reached the lowest point.

The current policy showed that no matter whether the ECB further lowers the interest rate or not in June, the rate to be announced then would probably be at the lowest level.

Several policymakers have said they do not hope the rate will drop below 1 percent for practical and psychological reasons.

As the last major measure, the ECB announced Thursday that the European investment Bank (EIB) will become an eligible counterpart in the Euro system's monetary policy operation since July.

The EIB is mainly responsible for providing loans for small and medium-sized enterprises (SMEs), the financing of which was hit hard by the current international financial crisis.

Analysts believed that the coordination between the EIB and the ECB can effectively help the SMEs face the crisis.

SIGNS OF HOPE

Trichet said the latest data and survey information suggested some positive signs of stabilization "albeit at low levels."

For example, the business climate index of the euro zone rebounded in April, its first improvement since may 2008.

But "overall, economic activity is going to be weak for the remainder of the year before gradually recovering in the course of2010," said Trichet.