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Key eurozone interest rate cut

President Mario Draghi (right) said interest rates would stay low for an extended period and the European Central Bank will offer banks cheap loans through mid-2015.

Ralph Orlowski/Reuters

President Mario Draghi (right) said interest rates would stay low for an extended period and the European Central Bank will offer banks cheap loans through mid-2015.

FRANKFURT — In a surprise, the European Central Bank cut its benchmark interest rate to a record low Thursday, moving more quickly than expected to stimulate the eurozone economy in the face of falling inflation.

The ECB cut its main rate to 0.25 percent from 0.5 percent, which was already a record low.

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The central bank and its president, Mario Draghi, were reacting to a sudden drop in eurozone inflation, which fell to an annual rate of 0.7 percent in October, much lower than the ECB’s official target of about 2 percent. The fall raised the specter of deflation — a sustained fall in prices that can destroy the profits of companies and the jobs they provide.

Many economists and political leaders will applaud the decision, which is likely to weaken the euro against the dollar and help European exporters. European stocks were mixed on the news, with exchanges in Paris and Frankfurt initially up more than 1 percent and then falling flat, while the euro fell more than 1 percent against the dollar. A cheaper euro makes European products less expensive abroad.

But the decision also carries some risks. It could be interpreted to mean that the ECB is more concerned about deflation and slow eurozone growth than analysts expected, an interpretation that could undermine confidence. And the decision to cut to 0.25 percent leaves the ECB with little room to maneuver if economic conditions worsen.

The decision may also be received with dismay in Germany, where concern about excessive inflation has deep roots. The ECB cannot risk alienating Germany, which has the largest economy in the eurozone.

“Deflationary risks and the stronger euro seem to have motivated the ECB move,” Carsten Brzeski, an analyst at ING Bank, said in a note to clients. “It is obvious that the ECB under President Draghi has become much more proactive than under any of his predecessors.”

The ECB’s prime mandate is to defend price stability, which also means intervening if inflation is too low. But most analysts expected the ECB to wait until December to act, once there was more economic data available.

At a news conference, Draghi said interest rates would stay low for an extended period. The central bank will also keep supplying banks with cheap loans through mid-2015, he said, but he did not disclose a new round of long-term, three-year loans. The eurozone is not in a period of Japan-style deflation, he said. On the contrary, price declines in some countries are welcome because they make them more competitive on international markets, he said.

Some economists have argued that falling inflation, coming after five years of recession or very slow growth, means that the eurozone faces an acute risk of deflation. While lower prices might seem like a good thing for consumers,deflation is considered more dangerous than runaway inflation. When prices fall, consumers and businesses delay purchases because they expect goods to become even cheaper. Corporate profits decline, and companies are forced to pay their workers less.

Deflation could be particularly destructive in Europe, where governments, banks, and private households are struggling with excess debt.

It is unclear, though, what effect the rate cut will have, given that market interest rates are already effectively less than zero.

The view in Germany and among some economists is that there is no threat of deflation. This group sees slowing inflation merely as a sign that wages are falling in countries like Spain and Greece, where labor costs had become too high for companies to compete in the international marketplace.

It is likely that Jens Weidmann, president of the German central bank and a member of the ECB Governing Council, argued against a rate cut.

Although the eurozone emerged from recession this year, recent economic indicators have sent conflicting signals about the strength of the recovery. Few economists expect a strong rebound, but some have been more pessimistic than others, warning of long-term stagnation if the ECB does not do more to stimulate lending and growth.

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