ECB split rate decision does not mark major policy divide

FRANKFURT Fri Nov 8, 2013 3:43pm GMT

European Central Bank (ECB) President Mario Draghi gestures during his speech at the ''German Economic Forum'', organised by German weekly newspaper ''Die Zeit'', in the St.Michaelis church (nicknamed ''Michel'') in Hamburg, November 7, 2013. REUTERS/Fabian Bimmer

European Central Bank (ECB) President Mario Draghi gestures during his speech at the ''German Economic Forum'', organised by German weekly newspaper ''Die Zeit'', in the St.Michaelis church (nicknamed ''Michel'') in Hamburg, November 7, 2013.

Credit: Reuters/Fabian Bimmer

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FRANKFURT (Reuters) - The European Central Bank's split over Thursday's decision to cut interest rates does not mark a major philosophical division among the 23 Governing Council members, people familiar with the discussion say.

The ECB cut its main rate to a new record low of 0.25 percent, taking financial markets by surprise.

Around a quarter of the council members, led by Bundesbank chief Jens Weidmann, spoke out against a cut this month, a source familiar with the discussions told Reuters.

ECB President Mario Draghi told his post-meeting news conference there was general agreement on the need to act but differences over when to act.

A "considerable majority" on the Council saw sufficient evidence of broad-based and protracted low inflation to cut at Thursday's meeting, he said, while others wanted to wait to see incoming data over the next month.

In December, the central bank will produce fresh economic forecasts which some thought would give a more solid basis for action.

Insiders say Draghi supported chief economist Peter Praet's proposal to cut and that there was no blazing row over the policy decision.

"It was broadly a question of timing," one person familiar with the decision said.

The ECB had faced intense pressure to act this week after a shock slump in euro zone inflation to 0.7 percent in October, far below the ECB target of just under 2 percent.

Draghi, who stressed the ECB still had room to act if needed, explained the rationale behind the decision to cut at a forum in Hamburg late on Thursday: "We had a figure in October which was lower than we had expected," he said.

"But even without that, if one looks at the figures that are analysed over the last two quarters, you see that actual inflation is declining fast so we had to act to bring it back."

WHAT NEXT?

Business leaders are hoping the rate cut breathes some more life into the euro zone economy.

"The timing (of the cut) was surprising, but Mr Draghi is known for surprise moves. The big question is, what is the effect?" Dieter Wemmer, Chief Financial Officer at Europe's largest insurer Allianz(ALVG.DE), told reporters on Friday.

"One can only wish the ECB success," he said.

Ewald Nowotny, the Austrian member of the Governing Council, said the ECB cut rates to support the euro zone's economic recovery.

"We are away from the nadir of the economic crisis but it is still a very slow upturn," he told Austrian television. "We do not want to jeopardise this slow upturn." [ID:nL5N0IS5AS]

But what if the recovery falters despite the rate cut?

With little room to lower interest rates further, the ECB would have to look at other measures in its policy toolkit.

Such options include issuing further LTROs - long-term refinancing operations that offer cheap, unlimited, loans to banks - or even quantitative easing along the lines pursued by the U.S. Federal Reserve.

The so-called 'hawks' on the ECB Council, the Weidmann-led camp of conservative policymakers from core euro zone countries, have a much higher resistance threshold to employing such measures than to the 'standard' business of cutting rates.

Weidmann was the sole Council member last year to oppose Draghi's plan to create a new ECB bond-purchase programme to back up his promise to do "whatever it takes" to save the euro.

Draghi, an Italian with an economics doctorate from MIT, has shown a greater propensity to take bold action than his predecessor at as ECB president, Jean-Claude Trichet, who stuck closer to the Bundesbank image in which the ECB was formed.

Draghi presided over rate cuts at his first two meetings at the ECB helm. At the second of those, in December 2011, the ECB also decided to offer banks twin 3-year LTROs - a step that saw the ECB pump over 1 trillion euros into the financial system.

UNIQUELY INDEPENDENT

A majority - 35 of 59 - of economists polled by Reuters after Thursday's policy meeting said the ECB would conduct more LTROs within the next six months, with a median expected maturity of three years.

Thursday's rate cut underlines the morphing of the ECB into a more pro-active central bank.

Jacob Kirkegaard of the Peterson Institute for International Economics, said governments' progress in building up euro zone institutions - such as the European Stability Mechanism (ESM) - would give the ECB more freedom to act.

"In the long term, the ECB's latest easing decision reflects how this uniquely independent central bank is gradually being freed from its political requirement to get an explicit quid pro quo ahead of time from euro area political leaders before easing the area's monetary and financial conditions," he wrote in a research note.

EU leaders' backing in June 2012 for a roadmap towards deeper euro zone integration gave Draghi the cover he felt he needed to deliver his pledge a month later that the ECB was ready to do "whatever it takes" to save the euro.

"The timing of ECB actions in the future will no longer be as dictated by political developments as in the past — a reflection of the euro area's new stability," Kirkegaard wrote.

(Additional reporting by Katrin Jones, editing by Mike Peacock)

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