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ECB Cuts Interest Rate

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The European Central Bank unexpectedly cut its interest rate a quarter point to 1.25% at its first meeting with new President Mario Draghi at the helm. Markets reacted favorably to the move, with the DAX up 2.8%, the CAC 40 2.7% and the FTSE up 1.1%.

Draghi has taken office in the midst of a crisis, between worries over a proposed Greek referendum (which the Greek prime minister retracted on Thursday) on its latest bailout package that could lead to its expulsion from the eurozone and strife at home in Italy over Prime Minister Silvio Berlusconi’s handling of the country’s financial woes. Reuters reported that, although inflation has been, at 3%, running well over the ECB’s goal of under 2%, officials decided that the move was necessary.

The next sign markets are looking for is an indication of whether the ECB will continue to purchase bonds of peripheral eurozone countries. Draghi had appeared to indicate a willingness to continue with the policy before taking his new office, but former head of the ECB Jean-Claude Trichet said that Draghi’s remarks were misinterpreted. Trichet had been in favor of the ECB ceasing such purchases once the European Financial Stability Facility came into its new powers so that the latter could intervene in bond markets instead.

Draghi will have to tread carefully; markets want a grander intervention to help lower the borrowing expenses of Spain and Italy, and Germany is opposed.