Welcoming in the European Ultra-loose Monetary Policy

The European Central Bank cut its key interest rate and launched a sweeping package of bond purchases Thursday.

The European Central Bank announced a cut to its key interest rate and the start of a package of bond purchases. With a climate where negative interest rates are already present such a move makes way for an ultra-loose European monetary policy. This is sure to have a big effect on European financial markets and will most likely trigger a response from President Trump.

The ECB said it would cut its key interest rate by 0.1, to minus 0.5%, and start buying €20 billion ($22 billion) a month of eurozone debt. This new quantitative easing program is expected to “run for as long as necessary,” and only to end shortly before the bank starts raising interest rates, the ECB said.

Mario Draghi, the President of the ECB, has laid out a package that is the ECB’s largest in 3½ years. It will force his successor, Christine Lagarde (who will take office on Nov. 1), to negative interest rates and an open-ended bond-buying program for an undetermined amount of time.

At a news conference, Mr. Draghi said the ECB had acted in response to persistently weak inflation, and a drop in investors’ expectations for future inflation. Recent economic data have shown “a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures,” he said.

The euro fell sharply against the dollar after the decision was announced, down 0.4% at $1.10, and eurozone government bonds rallied.

Second-quarter figures released Thursday showed year-to-year economic growth in the Group of 20 leading economies was at it lowest since 2013.

The Fed is expected to cut its key interest rate by a quarter percentage point next week, following a similar cut in July, its first since 2008.

In a tweet, Mr. Trump said the ECB was “trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports.... And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!”

“The final showdown has started with a big bang,” said Carsten Brzeski, an economist with ING in Frankfurt.

Government bond yields fell across Europe because of the package. Benchmark German 10-year bund yields traded at minus 0.66%, down from minus 0.56% earlier in the day. Italian 10-year bond yields dropped sharply, to 0.80% from above 1% earlier in the day. Yields on U.S. Treasurys also fell.

The ECB also promised not to raise interest rates “until it has seen the inflation outlook robustly converge” with its target of just below 2%. Thursday’s cut was the ECB’s first since March 2016.

“Despite all market excitement now, the question remains whether this will be enough to get growth and inflation back on track as the real elephant in the room is fiscal policy,” said Mr. Brzeski.

By launching such a bold stimulus package, Mr. Draghi has left the central bank with very little ammunition to fight any new downturn.

“We have relevant headroom to go on for quite a long time at this rhythm without the need to raise the discussion about limits,” Mr. Draghi said.

Unlike the Fed, the ECB never raised interest rates or trimmed its bond holdings during the economic recovery.

Eurozone inflation has been running far beneath the ECB’s target rate of just below 2%, and it isn’t expected to return to target for years.

With interest rates falling further below zero, the ECB also moved Thursday to provide relief for the region’s embattled banks, whose profits have been hurt by negative interest rates. The ECB will create a mechanism to shield banks from the full force of negative rates, and sweeten the terms of a fresh batch of long-term loans.

Mr. Trump has repeatedly criticized the Fed for being less aggressive, tweeting on Wednesday that it should cut interest rates “to ZERO, or less.”

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