The European Central Bank (ECB) has announced a cut to interest rates and a new €400 billion (£323 billion) programme to boost bank lending as it acts to ward off deflationary pressures.
The ECB has cut its main rate, which is used as a benchmark for consumer borrowing, from 0.25% to 0.15%. And it has entered unchartered territory by introducing a negative deposit rate, of -0.1%, meaning banks will be charged to park their cash with it. The rate for the ECB’s marginal lending facility has also been cut, from 0.75% to 0.40%. ECB president Mario Draghi said rates were likely to remain at those levels 'for an extended period of time in view of the current outlook for inflation'.
Draghi has also announced the launch of a new long term refinancing operation (LTRO) designed to boost bank lending. The ECB will provide €400 billion of cheap loans to banks in two rounds, in September and December this year. Banks will be able to borrow up to 7% of the value of their loans to the 'non-financial' parts of the eurozone economy, not including mortgage lending, at a rate of 0.10% above the ECB's main interest rate, which now stands at 0.15%.
He said the ECB was also looking at buying asset-backed securities from banks, allowing them to sell on their small business loans.
The ECB has also cut its economic forecast for this year from 1.2% growth to 1%, although it expected 1.7% growth in 205, up for its previous 1.5% prediction. Inflation is expected to reach 0.7% this year, 1.1% in 2015 and 1.4% in 2016.
Draghi said the measures would 'contribute to a return of inflation rates to levels closer to 2%'. 'Inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining rates below, but close to 2%,' he said.
The euro, which had been hovering around four-month lows in the run-up to the announcement, slumped to $1.3530 on the news. The FTSE 100 jumped 28 points, or 0.4%, as Draghi outlined the ECB's stimulus actions. Eurozone index the Euro Stoxx 50 hit a session high, up 1.1%.
The ECB has cut rates in a bid to stave off the threat of deflation in the eurozone. Inflation currently stands at just 0.5%, well below the ECB’s 2% target, while gross domestic product growth fell to 0.2% in May.
Carsten Brzeski, economist at ING, said the ECB had 'entered new unchartered territory in its quest to support the eurozone economy' by introducing a negative deposit rate.
'Will it help to kick-start the economy? Probably not, but at least it demonstrates the ECB's determination and ability to act,' he said.
Azad Zangana, European economist at fund group Schroders, disputed the rationale behind negative deposit rates.
'We have disagreed with the move to cut the deposit rate in the past, as we expect banks to simply pass on the costs to households and businesses, either by charging fees for savers, but more likely through higher interest rates on new borrowers - the opposite of what the ECB is trying to achieve,' he said.
Earlier, the Bank of England monetary policy committee kept UK interest rates on hold at 0.5%.
FTSE drifts lower on day of reckoning for ECB
10:22 The FTSE 100 has drifted lower ahead of today's European Central Bank (ECB) meeting, which is expected to yield stimulus action in the face of deflationary threats for the eurozone.
Traders have remained cautious in the run-up to the meeting, with the UK blue-chip index shedding eight points, or 0.2%, to 3,635.
With inflation in the eurozone currently standing at 0.5%, well below the ECB's 2% target, and gross domestic product growth having fallen to 0.2% in May, ECB president Mario Draghi is widely expected to announce stimulus measures. Cuts to interest rates are expected, as are measures to ease bank lending. The euro has been hovering around four-months lows in the run-up to the meeting, and is currently trading at $1.3611.
'Expectations have been running high since president Draghi's statement in last month's press conference that the ECB is "comfortable" taking action in June,' said CMC Markets UK analyst Jasper Lawler.
'Subsequent supportive statements for unconventional measures from the German Bundesbank have added to speculation that something big is about to go down.'
Smith & Nephew (SN) bucked the trend for caution, however, jumping 5.2% to £11.19 on reports the medical device maker could be subject to a bid from US rival Medtronic (MDT.N).
Bloomberg has reported that Medtronic's preparations for a bid are at an early stage and that no offer is imminent. Smith & Nephew's share price has surged in the past two weeks on takeover talk, with US company Stryker (SYK.N) last week forced to deny it was preparing a bid.
Miners were amongst the losers after data showed growth in the services sector of top metals consumer China retreated to a four-month low in May. The China services purchasing managers' index fell to 50.7 last month from 51.4 in April. Any reading above 50 indicates expansion. Randgold Resources (RRS) was the worst hit, falling 1.5% to £43.21, while Fresnillo (FRES) fell 1.1% to 780.8p and Anglo American (AAL) fell 1.2% to £14.44.
Outside the FTSE 100, shares in haulier and freight services provider Wincaton (WIN) surged by 9.7% to 130.8p after the FTSE Small Cap company announced a 20% rise in profits and revealed new contract wins.