MercoPress. South Atlantic News Agency

Europe appeals to negative interest rates to stimulate the economy and inflation

“Are we finished? The answer is no. We aren't finished here. If need be, within our mandate, we aren't finished here” said Dragui

The European Central Bank has introduced a raft of measures aimed at stimulating the Euro zone economy, including negative interest rates and cheap long-term loans to banks. It cut its deposit rate for banks from zero to -0.1%, to encourage banks to lend to businesses rather than hold on to money. The ECB also cut its benchmark interest rate to 0.15% from 0.25%.

 The ECB is the first major central bank to introduce negative interest rates.

Howard Archer, chief UK and European economist at IHS Global Insight said: “Despite being widely anticipated and in some quarters criticized for occurring too late, it is still a bold and unusual move by the ECB to take its deposit rate into negative territory.”

“There has to be considerable uncertainty as to how effective negative deposit rates will turn out to be,” he added.

It has been tried before in smaller economies. Sweden and Denmark, who are both outside the Single Currency, attempted to use negative rates in recent years with mixed results.

Analysts said in Sweden it had little discernible impact; in Denmark it did have the effect of lowering the value of the currency, the Krone, but according to the Danish Banking Association it also hit the banks' bottom line profits.

The ECB's president, Mario Draghi, also announced other measures.

Long term loans are to be offered to commercial banks at cheap rates until 2018. These loans would be capped at 7% of the amount that the individual banks in question lend to companies. Thus, the more the banks lend to companies, the more money they can borrow cheaply from the ECB.

It is also doing preliminary work that could lead to buying bundles of loans that are made to small businesses in the form of bonds. This is being seen as a step towards providing companies with credit through the financial markets.

Mr Draghi said the ECB's policymakers unanimously agreed to consider more unconventional measures to boost inflation if it stays too low. The ECB stopped short of instituting a large asset-buying program like the quantitative easing (QE) undertaken by the US Federal Reserve. However Mr Draghi insisted that more would be done, if necessary.

“Are we finished? The answer is no. We aren't finished here. If need be, within our mandate, we aren't finished here.” he said.

Draghi said that the whole package of measures was aimed at increasing lending to the “real economy”, and “now we are in a completely different world”.

Even though some of the measures, like the more to negative rates on deposits, were expected European shares moved higher on the ECB announcement.

The benchmark German Dax 30 index jumped above the 10,000 level for the first time. The Cac 40 in Paris was up 0.8% shortly after the ECB's comments. Meanwhile, the Euro fell to 1.3558 dollars, its lowest level in four months.

Although the danger of deflation in the Euro zone is limited, the ECB is concerned that growth is very sluggish and bank lending weak - both of which could potentially derail the fragile economic recovery.

The Euro zone economy grew by just 0.2% in the first quarter of the year. Consumer spending, investment and exports are all growing at a slower pace than this time last year. Inflation in the Euro zone fell to 0.5% in May, down from 0.7% in April. This is well below the European Central Bank's target of just below 2%.

If the Euro zone slips into deflation, the fear is that consumers might spend even less because they would expect prices to fall in future months. For the same reason investors could stop investing.

Unemployment, which is already at nearly 12% in the Euro zone, and much higher in places like Spain, Portugal and Greece, could get even worse.