ECB Cuts Key Rate to 1%, May Dig Into Toolbox as Recession Looms

The European Central Bank cut interest rates for a second straight month and may delve even deeper into its toolbox today to stimulate bank lending and fight off a recession.

ECB policy makers meeting in Frankfurt lowered the benchmark interest rate by a quarter percentage point to 1 percent to match a record low, as expected by 55 of 58 economists in a Bloomberg News survey. They may also loosen collateral criteria to give banks greater access to cheap cash and offer longer-term loans, said three euro-area officials with knowledge of the deliberations. ECB President Mario Draghi holds a press conference at 2:30 p.m.

“They will have listened to the banks and will start some measures to alleviate some of the strains in markets,” said Christoph Rieger, head of fixed income strategy at Commerzbank AG in Frankfurt. “They will also keep open the option to go below 1 percent on rates, that’s no longer the magic floor.”

The ECB is focusing on getting banks lending again rather than increasing its government bond purchases to fight the debt crisis. Later today, Europe’s leaders will convene in Brussels for talks to frame the fifth “comprehensive” solution in 19 months to the turmoil, which has left Germany and France facing the threat of losing their AAA rating from Standard & Poor’s.

Bank of England

The ECB’s insistence that governments take measures to restore investor confidence appears to have paid dividends, with Italian and Spanish yields plunging after Germany and France agreed to move the 17-nation euro area toward a fiscal union.

The Bank of England kept the size of its asset-purchase program unchanged at 275 billion pounds ($432 billion) today and left its key rate at 0.5 percent.

Investors will look for signs from Draghi that the ECB is willing to step up its bond purchases to cap government borrowing costs if leaders agree on a concrete plan and timeline to stamp out the crisis, said Grant Lewis, head of research at Daiwa Capital Markets in London.

“Even if it does, and we continue to have our doubts, a currency that has a central bank persistently providing finance to governments is not one that is likely to be a success in the long term,” he said.

Draghi said on Dec. 1 that the ECB’s bond buying “can only be limited.” If governments move toward a “fiscal compact,” there may be room for “other elements,” he said, without elaborating.

Leaders Meet

European Union leaders will meet for dinner at 7.30 p.m. in Brussels for talks that will continue tomorrow.

French President Nicolas Sarkozy and German Chancellor Angela Merkel are proposing to amend European treaties to tighten controls on budgets. Still, Germany rejects proposals to combine the region’s current and permanent rescue funds, a German government official told reporters in Berlin yesterday on condition of anonymity.

The ECB must step up its asset purchases, said Angel Gurria, secretary general of the Organization for Economic Cooperation and Development.

“The ECB is the ultimate weapon” and “has to be part of the solution,” he said yesterday in an interview in Durban, South Africa. “You are using a slingshot, where is the bazooka?”

Draghi has indicated the ECB will address signs of a credit squeeze, which falls squarely within its remit.

‘Credit Tightening’

The central bank has “observed serious credit tightening” and is “aware of the continuing difficulties for banks, due to the stress on sovereign bonds, the tightness of funding markets and scarcity of eligible collateral in some financial segments,” he said on Dec. 1.

Policy makers may broaden the pool of eligible collateral for ECB loans by loosening rules governing the use of asset-backed securities, said officials speaking on condition of anonymity.

The ECB is already lending banks as much money as they want against eligible collateral for periods of up to a year. It is likely to add two-year loans to its arsenal, two officials said. While a three-year loan has been discussed, it is unlikely at this stage, they said.

One official said the economic outlook has deteriorated markedly since Draghi said on Nov. 3 that the ECB expected a “mild recession.”

The OECD on Nov. 28 predicted euro-area growth will slow to 0.2 percent next year from 1.6 percent this year. The ECB will today publish its latest projections, including a 2013 inflation forecast that may justify further monetary stimulus.

Draghi said last week that the ECB’s goal is to maintain price stability “in either direction,” suggesting it would act as forcefully to prevent a significant undershooting of its 2 percent ceiling as it would to stop an overshooting.

“This applies to both the setting of official interest rates and the implementation of non-standard measures,” he said.

-- With assistance from Andres Martinez in Durban and Kristian Siedenburg in Vienna. Editors: Matthew Brockett, Simone Meier