European Central Bank to buy assets to stimulate growth

The European Central Bank has cut its interest rates and announced a new stimulus program that involves buying financial assets, a bid to salvage a weak economic recovery.

In a press conference following a meeting Thursday, ECB President Mario Draghi said the bank would start purchases of private sector financial assets in October.

The program aims to make credit cheaper, helping investment and growth at a time when the economy of the 18-country eurozone has stalled. The economy did not grow at all in the second quarter, raising fears of a triple-dip recession.

The bank also cut the interest rates to a record low of 0.05 percent from the previous low of 0.15 percent.  The benchmark refinancing rate determines what banks pay the ECB for credit. It influences what banks charge businesses and consumers to borrow.

The euro fell to its lowest level since July 2013, following weeks of decline on expectations that the ECB may pursue further stimulus measures. It is trading at below $1.30 US.

Trying to get banks to lend

Some investors had been expecting the ECB to say it was preparing a new stimulus program, but most did not expect an announcement as early as this week.

"This surprising move does showcase how eager the ECB are to encourage banks to lend again," said Jameel Ahmad, chief market analyst for FXTM.

The new program is somewhat different from the stimulus program that the Federal Reserve has undertaken with some success — large-scale purchases of government bonds — as the ECB is buying private assets.

Such purchases also have the potential to increase inflation. Right now that's a key goal for the ECB. Inflation in the eurozone is way too low at an annual 0.3 per cent. It's a sign the economy remains weak and makes it harder for governments to shrink their high public debt.

Bond yields across the eurozone fell. The yield on France's ten-year bond fell 0.10 percentage points to 1.25 percent, while Greece's dropped 0.19 percentage points to 5.62 percent.

The ECB also cut its deposit rate — what banks pay to keep their money at the central bank — to minus 0.2 percent from minus 0.1 percent. The negative rate is an effort to push banks to lend money by imposing a financial penalty for hoarding it in the safety of the ECB's accounts.

Lower rates stimulate more lending and growth. However, lower rates become less effective as a stimulus tool as they approach zero. That is why the ECB also announced further measures to boost credit to businesses.

Draghi said the ECB's governing council was divided on whether to approve Thursday's new program. They had also discussed a program to buy government bonds, instead of the private sector investments.

"Some of our council members were in favour of doing more, and some were in favour of doing less," he said.

The ECB program will buy asset-backed securities and covered bonds.

Growth outlook reduced

Asset-backed securities are investments based on assets such as loans to companies and mortgages. Buying them would stimulate the market for such bonds and for banks to make the loans that make up the assets. Covered bonds are similar, but have additional rights for lenders.

To reflect the darkening of the outlook for the eurozone economy, the ECB cut its growth forecast for 2014 to 0.9 per cent from 1.0 pe rcent previously. It lowered its inflation forecast for the year to 0.6 percent from 0.7 percent.

Draghi said that despite the new measures, the ECB cannot save the economy by itself and needs help from governments.

"You need growth. You need employment. You need structural reforms," he said.

At the same time, the Bank of England kept interest rates on hold on Thursday, leaving the bank rate at 0.5 per cent, where it has been since the depths of the financial crisis more than five years ago.

There had been speculation the British central bank might move to raise rates, because of the strength of the U.K. economy and the revival of inflation. 

However, the woes of the eurozone could weigh on the U.K.'s recovery,