Europe turns to stimulus with interest-rate cut

FRANKFURT, Germany The European Central Bank has cut its benchmark interest rate to a new record low to stimulate the lagging economy in the 17 countries that use the euro.

The bank's rate-setting council lowered the refinancing rate a quarter-point to 0.5 percent at a meeting in Bratislava, Slovakia.

The move comes amid fears the eurozone economy may defy ECB predictions and not recover from its recession later in the year. Governments in Europe are cutting spending and raising taxes to deal with problems with too much debt, hurting growth. Unemployment is at 12.1 percent, the highest since the euro's launch in 1999, and auto sales are slumping as consumers are afraid to spend.

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"The ECB's decision to cut interest rates to 0.5 percent comes as no surprise and was perhaps the minimum expected after recent weak news on the economy," said Jennifer McKeown, senior European economist with Capital Economics, in a research brief. "Note that the deposit rate was left at zero. The cut in the refi rate will marginally help those peripheral banks borrowing from the ECB, but won't address the disparity in interest rates facing firms and households in different countries or the credit constraints still facing [small and medium enterprises]."

The ECB's move cuts the cost of the credit it gives to private-sector banks. In theory, that should help companies create jobs by lowering the cost of the credit they need to expand. As the companies employ more people, consumer spending should also increase, boosting the eurozone economy further.

Markets, meanwhile, should also see rising stocks rise as investors bet that the cheaper borrowing rates will feed through to households and companies, boosting economic activity. The hope is that will result in higher earnings for the companies whose shares the investors buy.

The ECB decision helped shore up markets Thursday with Germany's DAX up 0.4 percent while the CAC-40 in France rose 0.2 percent. The euro, meanwhile, was trading 0.2 percent higher at $1.3207.

However, some economists have warned that this cut may not have much direct effect.

At the moment, banks in indebted eurozone countries such as Spain and Italy, where help from cheaper credit is needed the most, are not passing on low rates. Banks in these countries have to strike a balance between repairing their own finances so that they are strong enough to withstand any future financial shocks, trying to get other banks to lend to them and deciding whether to make potentially risky investments in companies. This means that many small and medium-sized businesses (SMEs), the chief job-creators in the economy, are not getting affordable credit.

ECB international relations chief Joerg Asmussen cautioned last week that any cut might only have "limited" pass through to the wider economy.

Some rates are so low they can't fall much farther annual interest on overnight euro loans between banks, for instance, is around 0.1 percent. But many companies still don't want to risk borrowing in a slow economy.

Still, a cut lowers costs for troubled banks that have taken emergency loans from the ECB and could help them repair their finances so they can lend a bit more. It also sends a signal of the ECB's willingness to support the economy by keeping rates down and looking for other ways to help growth.

"Admittedly, it is unlikely that the trimming of interest rates from 0.75 percent to 0.50 percent will have a major growth impact, especially given fragmented credit markets," IHS Global Insight analyst Howard Archer wrote in a research note.

"But any potential help to the eurozone economy in its current state is worthwhile."

ECB President Mario Draghi has said the bank is looking at non-interest rate steps that could help unblock lending to small and medium sized companies, who provide most of the jobs in Europe. He has mentioned working with governments or with the European Investment Bank, which already supports loans to smaller companies.

Markets are waiting for Draghi's post-decision news conference to see if any such measures will be announced, and to hear his outlook for the economy.