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ECB Biggest Interest Rate Cut in History Heading for ZIRP

Interest-Rates / Euro-Zone Dec 04, 2008 - 01:18 PM GMT

By: Mike_Shedlock


Best Financial Markets Analysis ArticleThe race to Global ZIRP took another big step forward today as central bankers around the globe cut rates. Let's take a look at the recent action .Europe's Central Banks Lower Rates to Fight Recession

The European Central Bank delivered a 75 basis-point reduction in its main refinancing rate, the most in its 10-year history, while the Bank of England cut its benchmark rate to 2 percent, the lowest level since 1951. The Swedish and Danish central banks also lowered their key rates.

“Policy makers are moving toward historically low levels of interest rates and they probably won't stop there,” said Paul Dales, an economist at Capital Economics Ltd. in London. “We are going to see all central banks bring rates down as close to zero as they can get.”

Bank of England Governor Mervyn King discussed the possibility of lowering the U.K. rate to zero for the first time on Nov. 25 and said the biggest challenge he faces is renewing the flow of credit in the economy.

The U.K. interest rate now matches the lowest in the central bank's history. It was last at 2 percent when Winston Churchill's victory in a general election made him prime minister for the second time.

“If this goes wrong we are just going to go sideways for the next decade,” Graeme Leach, chief economist at the Institute of Directors in London, said in a television interview.

ECB's Trichet Says Euro-Region Economy Will Contract

European Central Bank President Jean- Claude Trichet said the euro region's economy will shrink next year for the first time since 1993 after the bank delivered the biggest interest rate cut in its 10-year history.

The ECB lowered its benchmark by three quarters of a percentage point to 2.5 percent. Trichet declined to give clues on further moves, saying only that the ECB shouldn't get “trapped” by cutting rates too low.

As well as cutting rates, the ECB has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said today it may be possible for the bank to purchase financial assets outright to reflate the economy, although he declined to say if it would.

New Zealand Cuts Key Interest Rate by Record to 5%

New Zealand's central bank cut its benchmark interest rate by a record 1.5 percentage points to 5 percent and signaled more reductions to come as it attempts to steer the economy out of it worst recession in 18 years.

“Today's decision takes monetary policy to an expansionary position,” Reserve Bank Governor Alan Bollard said in a statement in Wellington today. “Some further but significantly smaller reductions in interest rates may be warranted.”

U.K. Pound Trades Near Record Low Versus Euro as BOE Cuts Rate

The pound traded close to an all-time low against the euro and near the weakest since 2002 versus the dollar as the Bank of England cut its key interest rate to the lowest level since 1951.

“Overall the 100 basis-point cut is going to be seen as disappointing,” said Ian Stannard, a foreign-exchange strategist at BNP Paribas in London. “Although 100 basis points was fully priced in, expectations were rising during the day for an even bigger rate cut.”

The pound fell to $1.4638 by 2:30 p.m. in London, from $1.4784 yesterday. It was at 86.54 pence per euro, from 86.01, after weakening to a record low of 86.96 pence.

Indonesia Unexpectedly Cuts Key Rate to Boost Growth

Indonesia's central bank unexpectedly lowered interest rates for the first time in a year to shield Southeast Asia's biggest economy from the global recession.

Governor Boediono and his seven colleagues reduced the benchmark rate to 9.25 percent from 9.5 percent, Bank Indonesia said in a statement in Jakarta today. Just six of 23 economists surveyed by Bloomberg News had forecast a cut.

Sarkozy Announces EU26 Bln of Measures to Spur Growth

French President Nicolas Sarkozy announced 26 billion euros ($33 billion) of measures to spur growth in an economy teetering on the brink of recession.

The aid, focused on public investment and early tax reimbursement for companies, totals 1.3 percent of gross domestic product and will increase the 2009 budget deficit to 3.9 percent of GDP from a projected 3.1 percent.

“Because the crisis is strong, the response must be strong,” Sarkozy said in a speech in Douai today. “The response to the crisis is a massive investment effort.”

Australia's Economy Grows 0.1%, Weakest in 8 Years

Australia's economy grew last quarter at the weakest pace in eight years as household spending stalled, increasing pressure on the central bank to add to the biggest round of interest-rate cuts since a recession in 1991.

The threat of Australia's first recession in 17 years has prompted central bank Governor Glenn Stevens to slash borrowing costs by three percentage points since early September. Consumers and businesses are reeling from a 44 percent slump in the benchmark Australian S&P/ASX 200 stock index and the biggest decline in home prices since 1978.

“A recession shouldn't be discounted by policy makers or the general public,” said Joshua Williamson, a senior strategist at TD Securities Ltd. in Sydney. “The outlook is more negative than positive.”

Australia Has More Scope for Rate Cuts, Former RBA Chief Says

Australia has room to lower interest rates further and increase government spending to support the economy amid the current global crisis, former central bank Governor Ian Macfarlane said.

Reserve Bank of Australia Governor Glenn Stevens, Macfarlane's successor, cut borrowing costs by 1 percentage point yesterday to a six-year low of 4.25 percent, extending the biggest round of reductions since 1991.

Macfarlane, the head of central bank between 1996 and 2006, said while the global credit crunch means there is a need for tougher rules, there is “no point in moving to a tougher regulatory regime until we get the present mess sorted out.”

“The immediate need is to get credit flowing again,” said Macfarlane, who is an adviser to Goldman Sachs Group Inc. “We must return to a situation where lenders will be prepared to take the normal commercial risks, without which no economy can function.”

From an international perspective, Macfarlane said the current situation is more serious than the dot-com bubble, the 1998 Long Term Capital Management hedge fund bailout, the Asian financial meltdown a decade ago, the mergers-and-acquisition bubble of the late 1980s, the 1987 share market collapse, the 1980s U.S. savings and loan crisis, and the so-called third world debt crunch of the early 1980s.

“We have never seen such a freezing up of lending between the banks before, and we have never seen a situation where in the U.S., the U.K. and Europe, so many banks and other financial institutions have had to be fully or partially nationalized in order to prevent their collapse,” he said.

Macfarlane said the crisis has also “invalidated” the model of a deregulated financial system that has operated in recent decades by transmitting instability among banks to the wider economy.

Soon these rates cuts will give way to Quantitative Easing as Bernanke and other Central Bankers sing the ever-popular Paul Simon Tune 50 Ways To Beat Deflation .

By Mike "Mish" Shedlock

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Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at .

© 2008 Mike Shedlock, All Rights Reserved

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