ECB Cuts Rates as Risk of Greek Euro Exit Grows

By Jeff Black and Gabi Thesing - Nov 3, 2011 9:24 PM GMT+0700

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Nov. 3 (Bloomberg) -- The European Central Bank unexpectedly cut its benchmark interest rate by 25 basis points to 1.25 percent as Italian and Spanish borrowing costs soared after euro-area leaders raised the prospect of Greece exiting the monetary union. Betty Liu and Michael McKee report on Bloomberg Television's "In the Loop." (Source: Bloomberg)

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Nov. 3 (Bloomberg) -- Carl Weinberg, founder and chief economist at High Frequency Economics, talks about European Central Bank's unexpected decision to cut interest rates at President Mario Draghi’s first meeting in charge. The ECB lowered its benchmark interest rate by 25 basis points to 1.25 percent. Weinberg speaks with Betty Liu and Michael McKee on Bloomberg Television's "In the Loop." (Source: Bloomberg)

The European Central Bank unexpectedly cut interest rates at Mario Draghi’s first meeting in charge as the new ECB head signaled officials have no plans to help bail out cash-strapped nations facing an escalating debt crisis that threatens to splinter the euro region.

“What makes you think that becoming the lender of last resort for governments is what you need to keep the euro region together?” Draghi told reporters in Frankfurt today. “ That is not really in the remit of the ECB. The remit of the ECB is maintaining price stability in the medium term.”

ECB officials unanimously lowered the benchmark interest rate by 25 basis points to 1.25 percent, confounding 51 of 55 economists in a Bloomberg News survey. Four predicted a quarter- point move and two expected a half-point reduction. Italian bonds fell after Draghi’s comments and the euro extended declines, dropping as much as 0.8 percent to $1.3657.

European leaders last night raised the prospect of the 17- member area breaking apart, with France and Germany saying they would treat Greece’s surprise referendum on a second bailout as a vote on its euro membership. With the region’s economic slowdown deepening and investors growing increasingly concerned, the ECB was under pressure to reverse this year’s two rate increases.

‘Wall of Money’

The ECB needs to “go into the market and say ‘We have a wall of money here and no matter how much speculation there is, we’re going to keep buying Italian bonds or any other euro bonds that are threatened’,” Irish Finance Minister Michael Noonan told Dublin-based RTE Radio yesterday.

Draghi rebuffed those calls, sticking to the line adopted by his predecessor, Jean-Claude Trichet. The bond purchase program is “temporary, it’s limited in the amount and it’s justified on the basis of restoring the functioning of monetary policy transmission channels,” he said.

The yield on Italy’s 10-year government bond rose 2 basis point to 6.21 percent. Earlier, it touched a record of 6.35 percent before falling to 6.13 percent in the hours leading up to Draghi’s press conference. Spain’s 10-year yield climbed 4 basis point to 5.46 percent.

The ECB cut rates partly because “what we’re observing now is slow growth heading toward a mild recession,” Draghi said.

“It’s a bold move by Draghi,” said Howard Archer, chief European economist at IHS Global Insight in London, who predicted a quarter-point cut. “He’s not going to be afraid of making bold moves, which is what’s needed in the current environment.”

Nearing Recession

Recent data indicate the euro region is edging toward a recession.

Unemployment in Germany, Europe’s largest economy, unexpectedly rose for the first time in more than two years in October and Europe’s manufacturing industry contracted for a third month.

While the current inflation rate of 3 percent is well above the ECB’s 2 percent limit, weaker growth and demand may drive down oil prices. The ECB currently forecasts inflation will slow to 1.7 percent in 2012.

The Organization for Economic Cooperation and Development on Oct. 31 lowered its growth forecast for the U.S. and the euro area. The U.S. economy, the world’s largest, will expand 1.7 percent this year and 1.8 percent next, the Paris-based OECD said. By contrast, the euro area’s will grow 1.6 percent in 2011 and just 0.3 percent in 2012, it said.

To contact the reporters on this story: Gabi Thesing in London at gthesing@bloomberg.net; Jeff Black in Frankfurt at jblack25@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net