THE European Central Bank lobbed in everything it could — bar quantitative easing — to counter the threat of a vicious bout of deflation.

Not only did the eurozone’s monetary guardian become the first major central bank to cut rates below zero, it also unveiled a package of liquidity measures to ease strains on credit-starved smaller businesses and signalled there would be more to come if inflation remained excessively low.

The latest projections on price pressures, published last Thursday, show why Mario Draghi and his colleagues on the governing council — all of whom backed this extensive package of measures — needed to take such drastic action.

The ECB targets inflation of just below 2pc, but in the year to May, prices grew by only 0.5pc. Crucially, the central bank’s new projections show inflation is expected to remain well below target by the end of 2016, with the ECB downgrading its forecasts from 1.7pc to 1.5pc.

The ECB has unveiled a targeted offer of four-year loans, designed to encourage banks to lend more to credit-starved SMEs

If inflation turns out as low as this, it will make the task of enhancing competitiveness and lowering debt burdens more difficult for countries in the bloc’s troubled periphery.

The ECB thinks it has done enough to show it is serious about returning inflation to target. The initial reaction from equity investors suggests they believe the central bankers. But doubts remain among economists about how effective the measures unveiled on Thursday will prove.

Negative rates: No major central bank has tried the radical step of cutting one of its key interest rates below zero. The cut to the deposit rate imposes a 0.1pc levy on reserves lenders park at the ECB. It will only be charged on so-called ‘excess’ reserves — those which banks do not have to hold as part of rules set by the central bank.

While the ECB hopes the move will lift inflation by weakening the euro and spurring lending in the bloc’s periphery, some economists believe the impact on the economy of such a small cut will be negligible.

However, the experience of Denmark’s Nationalbank was that the measure proved useful in depreciating its currency. The initial signs on whether the same would hold for the euro were mixed. After falling on the back of Mr Draghi remarks, the single currency later rallied and was up on the day by late afternoon in London.

The cut to the main refinancing rate to 0.15pc and the marginal lending rate to 0.4pc are not expected to have a significant economic impact.

Helping smaller businesses: The sharp fall in lending to businesses is one of the most worrying trends in the eurozone. The decline has been particularly pronounced for smaller firms in the periphery.

To address this, the ECB has unveiled a targeted offer of four-year loans, designed to encourage banks to lend more to credit-starved SMEs. To take advantage of the loans, which are available at a cheap fixed rate, banks must sign up to as-yet unspecified commitments on lending to businesses.

The offer will allow banks access to up to 400bn-worth of cheap loans, a figure which amounts to 7pc of all outstanding loans to businesses and households, excluding mortgages. A series of auctions will begin in September.

The terms of the facility were more generous than most had expected and economists were encouraged by the length of the loans. Jörg Krämer, chief economist at Commerzbank, said: “The ECB offered the banks a fixed-rate tender with a maturity of more than two years without any additional restrictions today — a very attractive opportunity from the banks’ vantage point.”

The operation is similar in design to the Bank of England’s Funding for Lending scheme. But, while that scheme is credited with spurring lending to households, it did little to improve borrowing conditions for businesses.

More to come: The ECB president sent a number of signals that the ECB could take further action. The central bank would “intensify preparatory work” on buying asset-backed securities, a move the ECB hopes would create a market for simple, transparent securitisations made up of repackaged SME loans.

The ECB president indicated the governing council would shift to a large-scale programme of asset purchases should inflation remain worryingly low.

Views were mixed, however, on whether the ECB had come closer to bond buying.

Richard Barwell, an economist at Royal Bank of Scotland, described last Thursday’s measures as a ‘firebreak’, which the governing council hoped would quell appetite for quantitative easing. But rather than dampen the flames, Mr Barwell thought the package would act as an ‘accelerant’ for large-scale asset purchases.

Published in Dawn, Economic & Business, June 9th, 2014