FRANKFURT – The European Central Bank announced on Thursday that it is preparing to cut short-term interest rates for the first time since 2016 and launching a gigantic bond acquisition program in a substantial political shift aimed at isolating the wobbling eurozone economy from global headwinds that span from trading tensions to Brexit.
The move underscores the ECB's activism during the outgoing president Mario Draghi, whose aggressive stimulation policy recently caught President Trump's attention. Trump attacked Mr. Draghi in a series of tweets last month, complaining that the Italian official had weakened the euro at the expense of US firms, but later suggested he might hire Mr. Draghi to the Federal Reserve.
The ECB's decisions over the coming weeks will be felt long after Draghi resigned in October.
While it stopped briefly from immediate action, the ECB's clear intentional signal increases the pressure on other major central banks, including the Fed, to follow up with interest rate cuts. The Fed is expected to lower interest rates for the first time in a decade when it meets next week.
In a statement, the ECB said it was "determined to act" to support inflation rates that have permanently undercut the central bank's target of just under 2%. It said it expected to keep the key rate at minus 0.4% or lower throughout the first half of 2020.
The economic outlook "gets worse and worse," especially in industry, Mr. Draghi said at a press conference on Thursday. "Basically, we do not like what we see on the inflation front." The ECB aims to keep inflation slightly below 2%, but it has missed this target for years, and the economic downturn brings it further out of reach.
The ECB said it had asked staff committees to investigate policy options including the possible design of a new bond purchase program. It has previously used such a language to signal that new action is imminent.
The next political meeting of the ECB is September 1
Initially, investors cheered the news, raised bond prices and some returns to new low levels, while also lifting European bank shares and selling euros. But these moves were all reversed when it became clear that Mr. Draghi would not present any details of the stimulus package for the time being.
Germany's 10-year yield on government bonds reached a record low of 0.461%, but rose again later as some investors sold bonds and settled at minus 0.406% in the afternoon. Similarly, the euro also fell to its lowest level of more than two years, but jumped back to being up 0.24% in the day to $ 1.117.
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Major central banks, from Asia to Europe, have signaled a return to ultra low interest rates in recent months amid growing global economy threats. Central bankers are eager to act early to safeguard the long-term economic expansion because they appear to have limited policy space to counter a low recession.
Eurozone is still rising and inflation is above 1%, not far from the ECB's target. There is a marked change from the ECB's last major stimulus round at the beginning of 2016, when the monetary union flirted with deflation, or a cycle of falling prices.
Still, economic indicators have started to flash red in recent months as the region's export-focused firms emerged as victims of US-China trade tensions.
The ECB's early signal can help reassure investors that the Central Bank still has the firepower to cope with fresh turbulence.
A move in September would simplify the early part of the course of Mr. Draghi's likely successor, CEO of the International Monetary Fund, Christine Lagarde, by not confronting her with immediate decision on how to deal with Europe's slowdown. Lagarde has a former lawyer and French finance minister, has no central bank experience, although Draghi called her an excellent choice on Thursday and pointed to her work at the IMF.
But it also raises legal and practical questions about how much more the ECB can achieve with its current toolbox. The bank's key rate is already below zero and the balance has risen to around 40% of the euro area's economic output, twice as high as the Federal Reserve.
“The ECB is still very optimistic and positive about the results provided by negative interest rates and asset purchases. I am more skeptical in this regard, "said Juergen Stark, former ECB economist, in a recent interview.
An interest rate cut of 0.1 percentage point, which is priced by investors," is nothing that will have no impact, "Stark said. Meanwhile, a recent round of bond purchases "will continue to disturb the markets and prices do not reflect the risk anymore," he said.
The ECB discontinued its controversial € 2.6 trillion bond purchase program, known as quantitative easing or QE, in December, among signs that the region's economy strengthened. To restart the program, the ECB will probably have to change self-imposed rules that prohibit the bank from buying more than 33% of a single government's debt.
Doing so will probably trigger new legal concerns in Germany, whose supreme court still considers lawsuits that challenge the legality of QE. A hearing in the case is scheduled for next week.
In an ominous signal, Mr. Draghi indicated that some of the ECB officials had opposed some of the bank's policy statement on Thursday. The German central bank president Jens Weidmann has been an outspoken critic of the ECB's bond purchases, even though he has softened the tone in recent months.
Critics argue that the ECB's monetary spending policy harmed the region's economy over time, including by keeping unproductive "zombie" companies alive, burdening the region's growth prospects.
"All this is not thought through, [it is] just to be an activist and show that we are not at the end of our toolbox," Stark said.
Write to Tom Fairless at email@example.com
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