European Central Bank Moves to Head Off Credit Crunch

From left, Chancellor Angela Merkel of Germany, President Nicolas Sarkozy of France and European Commission President Jose Manuel Barroso at the 20th congress of the European People's Party on Thursday in Marseille, France.

FRANKFURT — The European Central Bank moved aggressively to head off a recession and credit crunch in the euro area Thursday, cutting its benchmark interest rate for the second month in a row and taking unprecedented steps to expand emergency funding to cash-starved banks.

But stocks fell after Mario Draghi, the E.C.B. president, quashed hopes that the bank might drastically scale up its purchases of euro area government bonds to help contain the sovereign debt crisis. Yields on Italian and Spanish bonds rose, an indication that investors were more pessimistic about those countries’ creditworthiness.

At a news conference, Mr. Draghi said he was “surprised” that comments he made last week were interpreted as a signal that the E.C.B. would buy more bonds if political leaders, who are meeting Thursday and Friday in Brussels, delivered tougher rules on budgetary discipline.

“While Draghi had opened the door for more E.C.B. support last week, he closed it again today,” said Carsten Brzeski, an economist at Dutch bank ING. “According to Draghi, it was up to politicians to solve the debt crisis.”

On Thursday evening European leaders were to begin their latest summit meeting on the sovereign debt crisis that threatens to stifle economic growth far beyond Europe’s shores.

Taken together, the moves showed that Mr. Draghi, president of the E.C.B. for just over one month, is willing to break with precedent to combat the crisis, even as the bank awaits the outcome of the Brussels meeting.

At the same time, Mr. Draghi seems to remain unwilling to violate the ultimate E.C.B. taboo and effectively print money by buying bonds in massive quantities. Mr. Draghi also threw cold water on expectations the E.C.B. might use the threat of deflation as a justification to expand the money supply.

“We don’t see any high probability of deflation,” he said.

The E.C.B. cut its key rate to 1 percent from 1.25 percent, as expected, returning it to the record low level that had prevailed from 2009 until earlier this year.

The central bank also announced additional measures to aid euro area banks suffering from a dearth of money-market funding. The E.C.B. said it would begin giving banks loans for three years, compared to a maximum of about one year previously. The move means the E.C.B. is intervening for the first time in the market for medium-term bank funding.

Banks will be able to borrow as much as they want at the benchmark interest rate. They must provide collateral, but the E.C.B. on Thursday also broadened the range of securities it accepts, which will help banks that have large amounts of assets that are hard to sell on the open market. The E.C.B. also eased its requirements for reserves that banks must maintain.

The measures will also help smaller community banks that may not have been able to borrow from the E.C.B. because they lack the required collateral, Mr. Draghi said.

In a sign of how badly banks need the money, 34 institutions took advantage Wednesday of a new lower interest rate offered by the E.C.B. in conjunction with other central banks for three-month loans denominated in dollars. The banks borrowed a total of $50.7 billion.

Mr. Draghi, who took over the E.C.B. from Jean-Claude Trichet on Nov. 1, has wasted little time reversing the rate increases imposed in April and July. Those policy moves were widely criticized as an overreaction to tentative signs of inflation and may have helped hasten a widespread economic slowdown in Europe.

Lower interest rates will be particularly welcome in countries like Portugal and Italy, where the debt crisis has pushed up market interest rates and made it harder for businesses to get loans.

At their summit meeting Thursday night and Friday, E.U. leaders were to discuss ways to impose more central control on government spending to avoid future debt crises. Mr. Draghi had suggested that more action could follow if leaders made serious progress. But following his comments Thursday it is unclear what those measures might be.

The European economy is almost stagnant, growing just 0.2 percent in the third quarter, with unemployment at 10.3 percent. Economists expect the economy in the 17 E.U. nations that use the euro to slip into recession early next year if it has not already. Declining output makes the debt crisis even worse by cutting tax receipts.

Earlier Thursday, the Bank of England held its benchmark rate steady at 0.5 percent.