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By Jason Stipp and Robert Johnson, CFA | 06-05-2014 10:00 AM

ECB Puts Its Money Where Its Mouth Is--Will It Be Enough?

Morningstar's Bob Johnson sizes up the several stimulus measures announced by the European Central Bank Thursday.

Jason Stipp: I'm Jason Stipp for Morningstar.

The European Central Bank took several measures to stimulate the eurozone economy today. Here to offer his take on those measures is Morningstar's Bob Johnson, our director of economic analysis.

Thanks for joining me, Bob.

Bob Johnson: Great to be here today.

Stipp: Before we talk about the measures that were announced by the ECB, let's talk about the general economic situation in the eurozone and why these measures were perceived to be necessary.

Johnson: A couple of weeks ago we got some news on eurozone GDP, which grew 0.2% between the fourth quarter and the first quarter, and you annualize that, it's 0.8%, and that was below expectations. Certainly the U.S. is growing faster, China is growing faster. It's one of the lowest growth rates out there. So, that was a concern

And there was some fear that it had slowed even more recently. The PMI, the purchasing managers' surveys, for Europe had dropped from 54-55 in January back to the 52 level most recently. That indicator is a little bit more forward-looking. So that means things are going to be a little bit slower even.

And then the third thing that came out just two days ago, European inflation, came in at 0.5% year-over-year versus 0.7% the previous month. That 0.5% [inflation rate] is not quarter-to-quarter or month-to-month. That's May of last year compared to May of this year; they were only up 0.5% for Europe, and the target is 2%.

Stipp: What does that mean? Why is it so dangerous to have inflation so low?

Johnson: Because you start to build the deflationary expectations, and people hold off buying, thinking it's going to be cheaper tomorrow. It's harder to get rid of it. You have to do all these games--which frankly they started to do already, the negative deposit rates and all the really oddball stuff--and they really would like to avoid that. It's a lot easier to control monetary policy and economic growth when you've got at least a modest bit of inflation. But when you are in deflation, it's hard to fight your way out.

Stipp: So let's talk about some of the measures that they implemented, given that backdrop. The first was cutting a key interest rate to 0.15% from 0.25%. 0.25% was already pretty low, but they've moved it even lower.

Johnson: That's their main lending rate, and I'm surprised they haven't brought that rate down sooner. Frankly it's a little bit lower in the U.S. than what it was [in the eurozone]. Now this move brings us a little bit more in line. So that was good to see. And the emergency rate also came down a little bit more drastically from 0.7% to 0.45%.

And then the third component is … banks are paid money when they put imoney in the central bank usually, and in this case, they're going to charge banks a fee. They're actually going to make it a negative interest rate of 0.1%. The purpose there is to hope that banks will lend the money out rather than having a little bit of it confiscated every year.

Stipp: Do you think that's going to work?

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