ECB surprises markets with cut to key interest rate

• ECB surprises markets with rate cut
• Draghi signals inflation concerns
• Further rate cuts not on immediate horizon

LONDON — The European Central Bank surprised markets Thursday by cutting its benchmark interest rate 25 basis points to a record low 0.25%, a move that surprised economists and took the wind out of the euro currency.

"This seems to be primarily about October's inflation rate and the strength of the euro," said Jonathan Loynes, London-based chief European economist at Capital Economics.

In a separate note sent to investors, Loynes said that the "unexpectedly large fall in CPI inflation to just 0.7%, the strength of the euro exchange rate and growing concerns over liquidity conditions in the banking sector appears to have persuaded most (ECB Governing Council) members that some sort of reaction was necessary."

Immediately following the announcement the euro currency plunged against the dollar to $1.3368 — a drop of over 1% — and the region's major stock indexes rallied. Germany's DAX 30 index and France's CAC 40 index each advanced over 1% after the news was released.

ECB President Mario Draghi explained the reasons behind the cut during a press conference in Frankfurt, saying the cut was in line with the central bank's forward guidance provided in July. He said that even though inflation expectations for the region are firmly anchored, a "prolonged period of low inflation" is a possibility.

According to Eurostat's flash estimate, euro area inflation decreased in October to 0.7%, from 1.1% in September, on a year-ago basis. The ECB has a mandate to maintain inflation rates below but close to 2%.

Wall Street had been expecting the bank to maintain its refinancing rate at 0.5%, where it has been stuck since the spring.

"The ECB just surprised most analysts, including us," said Carsten Brzeski, an economist at ING Bank, in a note. "It is obvious that the ECB under President Draghi has become more pro-active than under any of his predecessors."

The 17 European Union member countries that use the shared euro currency returned to growth in the second quarter, but only just, with a 0.3% pickup in gross domestic product in the second quarter of this year after six quarters of falling output.

"Looking ahead, output is expected to continue to recover at a slow pace, in particular owing to a gradual improvement in domestic demand supported by the accommodative monetary policy stance," Draghi said. "Euro area economic activity should, in addition, benefit from a gradual strengthening of demand for exports."

As part of the ECB's efforts to support this growth Draghi said the bank will extend its offer of unlimited short-term credit to banks through the middle of 2015. He said that interest rates in the euro-area are likely "to remain at present or lower levels for an extended period of time."

The Bank of England made no changes to its monetary policy stance following the conclusion of its November meeting Thursday. The bank's benchmark interest rate was last lowered in 2009, to 0.5%.