ECB cuts rates as deflation fears grip euro zone

The European Central Bank today announced a 25 basis point reduction in its refinancing rate to a new record low 0.25 per cent, amidst a fall in inflation that raised fears the euro zone's economic recovery could stall.

ECB said the interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.25 per cent, starting from the operation to be settled on 13 November 2013.

The interest rate on the marginal lending facility will be decreased by 25 basis points to 0.75 per cent, with effect from 13 November 2013.

The interest rate on the deposit facility will remain unchanged at 0.00 per cent.

The 23-member governing council said the decisions follow a surprise slump in euro zone inflation to 0.7 per cent in October, which is far below the ECB target of close to 2 per cent.

The ECB cut interest rates in response to a slump in inflation that has sparked fears the euro zone's economic recovery could stall.

Italy was the loudest to raise fears of deflation, calling upon the ECB to loosen policy to help bring down the euro's exchange rate.

The euro slid more than 1 per cent on the day to hit a seven-week low of $1.3356, down from around $1.3490 just before the governing council of the ECB announced its policy decision.

European shares and German government bond futures rose.

ECB is also faced with the dilemma of supporting a fragile recovery amidst a fall in excess liquidity as banks repay 3-year ECB loans early before a health check next year.

ECB is now considering pumping more liquidity into the system to offset the effects of these early repayments, which could push interbank lending rates higher over time.

The cut in the main refinancing rate to 0.25 per cent could also potentially help delay repayment of loans under the long term refinance operation (LTRO), as lower interest costs make it more attractive for banks to hold on to the loans and invest them in higher-yielding assets.