European Central Bank has cut its benchmark interest rate to a record low 0.5 percent from 0.75 percent.

ECB European Central Bank

European Central Bank Lowered Interest Rate In Response To A Drop In Inflation

The European Central Bank has cut interest rates for the first time in 10 months on Thursday, amid ongoing worries about the eurozone’s economic health. Following the announcement, the euro rose to 1.3200 against the U.S. dollar from levels around 1.3060 prior to the release.

European Central Bank’s lowered its main interest rate in response to a drop in inflation well below its target level, and rising unemployment. ECB President Mario Draghi observed that the weak economic sentiment has extended into the spring of this year and hoped the cut in the interest rate would contribute to support a recovery later in the year.

Eurozone worries were compounded on Thursday as data showing manufacturing activity across the 17-nation bloc shrank in April, with Germany manufacturing contracted for the second month running. An interest rate cut lowers the costs for troubled banks that have taken emergency loans from the ECB, and could help them repair their finances so they can improve lending.

The decision to cut refinance rate by 25bp and retain the deposit rate at 0 percent doesn’t throw any surprises. The decision to cut the MLR by 50bp to 1.0 percent is a small bullish on the lower for longer. Hence the ECB has removed some of the tail risk for the OIS forwards.

However some of the most bullish components in ECB’s announcements include: 1) The European Central Bank stands ready to react to new data even if they are rather dismissive of deflation risk, 2) ECB’s announcement they are technically ready to cut the repo rate.

The European Central Bank has repeatedly voiced its concern about the impact this has on lending to small- and medium-sized enterprises (SMEs), which have little alternative to bank funding and are a key engine for growth in the currency bloc. Some analysts feel ECB will avoid making any formal statement on a potential SME programme.

Analysts at Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) (AMS:RBS) in their today’s report feel European Central Bank’s announcements are bullish for the market. They anticipate ECB might cut the refi rate again as the next move in H2-13, most likely beyond the September meeting. They feel it is possible that the refi rate can drop to 0.125 percent.

The Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) (AMS:RBS) analysts in their 2013 outlook predict investors will move away from money market funds to bonds. Besides there will be buyers of bonds in negative territory for Germany.

The Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) (AMS:RBS) report concludes that if the ECB goes negative, one of the cheapest assets on the plant would be front end Italy and especially Spain.