ECB cuts rate, tempers hopes for bigger bond buys

European Central Bank President Mario Draghi tempered market expectations for aggressive action by the bank to bail out heavily indebted euro countries if they agree to tougher rules on borrowing and spending.

Draghi spoke at a press conference Thursday after the ECB announced modest steps to help revive Europe’s economy and financial system, including cutting a key interest rate.

Stocks and the euro fell heavily, while borrowing costs for European governments rose. Bank stocks were particularly hard hit.

Based on comments Draghi made in a speech last week, hopes had been rising on financial markets that the ECB was preparing to ramp up its purchases of European government bonds as the eurozone economy slides toward recession. But on Thursday he said the bank had no explicit plan to do so and was ?surprised? by the way his remarks had been interpreted.

Draghi said the notion of the eurozone being broken apart by its worsening debt crisis was ?far-fetched? and that confidence in the 17 countries that use the euro would rise if leaders at a European Union summit in Brussels agree to a credible plan to enforce budget discipline.

Such a plan is ?the most important precondition for restoring the normal functioning of financial markets,? Draghi said.

The ECB announced several measures intended to stimulate lending and investing and bolster Europes financial system:

? It cut its key interest rate by a quarter percentage point to 1 percent. It was the second rate cut in only five weeks for the bank, the top monetary authority for the 17 nations that use the euro.

? It said banks could borrow unlimited amounts of ultra-cheap money for up to 36 months and that it would loosen rules on collateral for these loans by accepting lower-rated mortgages and bank loans.

? It also relaxed rules on how much capital banks must hold in reserve with the ECB. That will free up the banks to lend and invest more.

Draghi has said the eurozone economy could be heading for a mild recession. The rate cut is intended to promote economic growth and business optimism that policymakers are tackling the crisis. A slowing economy would only make it harder for European governments to pay down debt.

Analysts said the rate cut would have only a modest impact, at best. ?I thought they?d be more aggressive and cut by 50 basis points because the economy looks like it?s heading for recession and the banking sector is facing big pressures,? said Neil MacKinnon, global macro strategist at VTB Capital.

Large-scale bond purchases, however, would help drive down government borrowing costs, which have risen to crippling levels in Italy and Spain, Europes third- and fourth-largest economies.

By stabilizing the finances of Europes governments, the ECB would then strengthen the continent?s financial system. European commercial banks that own government bonds face potentially huge losses and, as a result, they have curtailed lending to each other, banks and consumers. That credit squeeze is felt globally.

But Draghi?s comments Thursday frayed the nerves of markets. Germany?s DAX stock index dropped 2 percent, while Italy?s FTSE MIB index dropped 4 percent. In the US, the Dow Jones industrial average fell 0.9 percent, with shares of JPMorgan Chase declining 2.4 percent.

European banks stocks fell even more. Italy?s Intesa Sanpaolo sank 7.2 percent, Frances Societe Generale fell 6.4 percent and Germany?s Deutsche Bank shed 4.3 percent.

The yield on the benchmark 10-year Italian government bond jumped a quarter of a percentage point, a large move, to 6.12 percent. The yield on Spain?s 10-year bond rose one-third of a percentage point to 5.71 percent.

?Investors who had been expecting some kind of great immediate action that was going to fix things are starting to get nervous,? said Fred Cannon, chief equity strategist at the investment firm Keefe, Bruyette

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