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New ECB leader Mario Draghi.

Mauro Scrobogna/AP

The new head of the European Central Bank made a dramatic debut at his first policy meeting, painting a picture of a stumbling economy headed toward recession and ushering in an interest rate cut that marked an about-face for the ECB.

Analysts expected Mario Draghi, the former chief of the Bank of Italy, to offer a gloomier assessment of economic and financial conditions across the euro zone. The latest data show manufacturing sliding, consumer spending slumping and unemployment rising in stronger and weaker economies alike.

But most observers thought he would wait at least another month before pulling the trigger on a rate cut, giving the bank time to assess the impact of the latest moves to combat the spreading debt crisis and safeguard the euro. Instead, the ECB reduced its benchmark interest rate by a quarter of a percentage point to 1.25 per cent, reversing a much-criticized hike by the bank just four months ago.

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His debut at the helm on Thursday comes at a time of unprecedented strains on the euro zone, as Greece teeters on the brink of collapse and possible withdrawal from the monetary union. For its part, the ECB faces intensifying pressures to take a more activist role in stopping the contagion stemming from the crisis.

"The economic outlook continues to be subject to particularly high uncertainty and intensified downside risks," Mr. Draghi said at his first press conference as the ECB's president. "Some of these risks have been materializing, which makes a significant downward revision to forecasts and projections for average real GDP growth in 2012 very likely."

The bank now expects "a mild recession by year end," he said.

"I thought that it was too early," Carsten Brzeski, senior economist with ING Bank in Brussels, said of the rate cut. "My German hawkish background would say 1.5 per cent was already very low. The euro zone economy is not falling off the cliff. It could get worse if the sovereign debt crisis gets worse. But so far it's a mild recession. It's obvious that the ECB has caught the crisis virus."

Still, Mr. Brzeski and other economy watchers agreed that deteriorating conditions, coupled with lower inflation prospects, made it a justifiable policy shift. Most analysts expect a further quarter-point cut by early next year.

"There was ample scope for the ECB to cut," said Howard Archer, chief European economist with IHS Global Insight in London, one of only a handful of analysts who predicted the ECB move. The latest Greek turmoil "obviously added fuel to it. But I think they would have cut anyway. All the economic fundamentals justify it."

It was the ECB's first rate decrease since May, 2009. Under his predecessor, Jean-Claude Trichet, the bank raised rates by a quarter of a percentage point last April and again in July, citing concerns about inflation. The ECB has been accused in the past of keeping rates too high for too long in the face of a weakening economy, because of an overriding focus on inflation.

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"Inflation has remained elevated and is likely to stay above 2 per cent in the coming months," Mr. Draghi said. But the bank's policy-setting governing council "concluded that the present situation would have a dampening impact on prices and costs," added the central banker, who has been at pains to emphasize his inflation-fighting credentials.

On the issue of the debt crisis, Mr. Draghi repeated the central bank's long-standing opposition to a greatly expanded role that would see it acquiring larger quantities of troubled government debt in the market and effectively becoming the region's lender of last resort.

"What makes you think that becoming the lender of last resort for governments is what you need to keep the euro region together?" Mr. Draghi asked at his press conference. "That is not really in the remit of the ECB. The remit of the ECB is maintaining price stability in the medium term."

Citing the characteristics of the existing securities purchasing program, Mr. Draghi emphasized that it remains temporary, limited in size and "justified on the basis of restoring the functioning of monetary policy transmission channels. We should keep that in mind because it answers all the questions one might have. We want our monetary policy to function."

But despite the bank's determined opposition to what amounts to cranking up the money-printing presses, the issue of a more aggressive ECB role in the crisis is likely to resurface.

"I would not exclude that eventually this will happen," ING's Mr. Brzeski said. "In the end, if they have to choose between two evils, either going down all the way to [being]an unconditional lender of last resort or the breakup of the euro zone, it's obvious what they're going to choose."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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