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ECB cuts interest rates to historic lows in battle against deflation

The European Central Bank has ventured into uncharted territory cutting all three of its key interest rates to record lows. The move aims to fight deflation and spur lending in the eurozone.

The European Central Bank’s rate-setting governing council lowered its refinancing rate for commercial banks on Thursday to 0.15 percent, down from 0.25 percent.

It also trimmed its marginal lending facility to 0.40 percent from 0.75 percent and cut the rate that governs the amount banks receive for depositing funds on a short-term basis to minus 0.1 percent.

It was the first time that the rate on deposits, known as the deposit facility, plunged into negative territory.

By introducing negative rates on deposits, the ECB will effectively collect fees to park money at the bank rather than pay out interest.

'Unconventional instruments'

"The governing council is unanimous in its commitment to using also unconventional instruments within its mandate should it become necessary to further address risks of too prolonged a period of low inflation," said ECB President Mario Draghi.

The reductions in the cost of money are part of a package of sweeping measures designed to pull the eurozone out of a low-inflation spiral and boost bank lending.

On top of the rate cuts, Draghi also announced the ECB would offer long-term loans to banks at cheap rates until 2018. The targeted loans would be charged a fixed rate, meaning that the rate could not rise over the life of the credits, giving banks confidence they have cheap funding out through 2018.

Moreover, the central bank is starting to do "preparatory work" to buy batches of loans to small businesses in the form of bonds, which is intended to funnel more credit to companies through financial markets.

Last arrows in its quiver

Finally, the ECB will stop collecting weekly deposits aimed at offsetting the monetary effects of earlier bond purchases. This will leave an additional 175 billion euros in the financial system that banks could theoretically use to lend to each other or to companies.

The rate cuts drew criticism from the head of the group of eurozone finance ministers, Jeroen Dijsselbloem, who called the fines levied on European banks "over-excessive" and "much too high."

The measures are is widely seen as the bank's last arrows in its quiver to combat deflation and sluggish growth in the eurozone. Inflation across the eurozone slowed to 0.5 percent in May, well below the ECB's target of 2 percent that it considers vital for price stability.

uhe/cjc (Reuters,dpa, AFP)