The latest move, agreed at a governing council meeting in Brussels, brought the ECB closer in line with other central banks that have announced even larger interest rate cuts in the face of rapidly-deteriorating economic conditions and plunging inflation rates. However, it could still disappoint financial markets who had urged a large reduction.
Earlier the Bank of England announced UK interest rates would be cut by a full percentage point, extending a 150 basis point cut last month. Sweden's Riksbank meanwhile cut rates by a dramatic 175 basis points.
Paralysis in financial markets has reduced the effectiveness of monetary policy in boosting the real economy – strengthening the case for bigger rate cuts.
The 15-country eurozone was already in recession in the six months ending in September, and the pace of its decline is thought to have accelerated recently. Purchasing managers’ indices have indicated gross domestic product could have contracted by as much as 0.5 per cent in the final quarter.
Revised ECB forecasts to be released later on Thursday could show GDP contracting overall in 2009. Despite a major monetary policy stimulus and some help from lower oil prices and a looser fiscal policy, we do not expect the economy to recover before late 2009,” said Holger Schmieding, European economist at Bank of America.
Eurozone inflation, meanwhile, plunged to 2.1 per cent in November and is expected to fall dramatically during next year, possibly even turning negative in some months.
ECB policymakers have argued that larger interest rate cuts risk further undermining already-fragile economic confidence and that central banks should keep their powder dry”. They have also played down the risk of deflation – a generalised and persistent fall in prices that wreaks significant economic damage.
However, Jean-Claude Trichet, ECB president, is likely to argue that the accelerated pace of monetary policy loosening reflected the fast-changing economic conditions, and was consistent with its focus on combating inflation.
The ECB cut eurozone borrowing costs by half a percentage point in early October and by the same amount last month. The latest move takes the main policy interest rate to 2.5 per cent, the lowest since March 2006.
The ECB aims to keep inflation below but close” to 2 per cent. Twice a year it holds interest-rate setting meetings outside its home base of Frankfurt, Germany.