European Central Bank announces emergency measures to protect euro

Mario Draghi, the president of the European Central Bank, has announced a battery of emergency measures to rescue Europe’s crisis-hit banks and unblock frozen financial markets, as Europe’s leaders gather to discuss the future of the single currency.

The Frankfurt-based lender said it would cut interest rates for the second time in two months; make three-year loans to cash-strapped banks; and accept a far wider range of collateral, including mortgage-backed securities and other A-rated assets, in exchange for emergency loans.

Individual central banks within the eurozone will also be allowed to accept bank loans in exchange for liquidity, at their own risk.

Explaining the ECB’s decisions at his regular press conference, Draghi said tensions in financial markets presented the greatest risk to Europe’s economy.

“Intensified financial tensions are continuing to dampen the economic outlook,” he warned.

The scale of the emergency measures, which also included a cut in the reserve ratios which banks are required to deposit with the ECB, from 2% to 1% from January, underlined how concerned the ECB has become about the risk of a credit crunch taking hold.

Banks have already seen their funding costs rise sharply as the eurozone financial crisis has worsened. Draghi said the “non-standard measures” were aimed at helping to unfreeze lending to households and businesses.

“These measures should ensure enhanced access of the banking sector to liquidity and facilitate the functioning of the euro area money market. They are expected to support the provision of credit to households and non-financial corporations.”

The ECB has also slashed its eurozone growth forecast for 2012, and is now expecting something between a 0.4% contraction, and 1% growth.

Under previous president Jean-Claude Trichet, the Frankfurt-based ECB was increasing interest rates as recently as July, amid fears of rising inflation in Germany, but they have become increasingly concerned about the risk of a double-dip recession, sparked by the debt crisis.

Nevertheless, Draghi admitted that the ECB’s governing council was not unanimous in deciding to administer a second interest rate cut in two months, to 1%.

The European Banking Authority will announce on Thursday evening how much each European bank will have to raise to repair its battered finances and protect the financial sector against the worsening downturn.

Draghi said: “The soundness of bank balance sheets will be a key factor in reducing potential negative feedback loop effects related to tensions in financial markets.”

Chris Williamson, of data provider Markit, said: “Despite inflation running stubbornly higher than the ECB’s 2% target, holding at 3% in October, it is becoming increasingly apparent that the region is sliding back into recession. The sovereign debt crisis has hit business and consumer confidence at the same time as austerity measures are dampening demand in many countries.”

Draghi also disappointed bond markets by playing down the idea that the ECB will step in with a radical rescue plan for Spain and Italy, if Europe’s leaders sign up to “fiscal compact”, constraining governments’ tax and spending policies.