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LONDON (Alliance News) - The European Central Bank finally moved Thursday to cut interest rates and prompt banks to lend more in an effort to stave off the threat of deflation, lifting stock markets in Europe.

However, UK stock indices lost the gains they made in the wake of the ECB policy changes, while the euro fell initially, but then recovered. The FTSE 100 eventually recorded its third consecutive lower close.

The ECB became the first major central bank to introduce negative interest rates, as it also introduced a raft of other measures aimed at boosting economic growth and easing deflationary pressure in the eurozone.

There was a huge amount of speculation over the past month about what measures the ECB might introduce, ever since the bank's President Mario Draghi said at the May meeting that the governing council was "comfortable with acting next time". That led to a collapse in both volatility and trading volumes in global equity and forex markets.

The volatility and some of the volume returned Thursday when the ECB announced a cut in all three of the rates that make up the ECB's primary policy tools. The benchmark refinancing rate was cut to 0.15%, from 0.25%, while the deposit rate was cut to minus 0.1%, from zero, and the marginal lending rate, at which banks can borrow overnight funds from the central bank, was cut to 0.4% from 0.75%.

The ECB's hand was forced after its staff lowered inflation projections, which Draghi had said he wanted to see before pulling the trigger on a policy change. The central bank now expects inflation by the end of 2014 to be 0.7%, down from the 1.0% it had predicted back in March. That comes after the most recent consumer price inflation data has shown prices in the eurozone rising at just 0.5% year-on-year in May, down from 0.7% in April and putting it well below the bank's 2.0% target.

"We are reacting to a risk of a too prolonged period of low inflation," Draghi said, as he unveiled a bigger package of measures.

That package included pretty much everything that was speculated about in the run up to the announcement, including the so-called de-sterilisation of the bank's securities market programme, and a new round of targeted long-term refinancing operations with a value up to EUR400 billion, all aimed at boosting lending, liquidity, and therefore growth.

The securities market programme involves the central bank intervening in markets to buy assets in the same way that the US and UK central banks have done. However, unlike the BoE and the Federal Reserve, the ECB "sterilises" the effect of this intervention by taking out deposits equal to the asset purchases, thus balancing the supply of money. To stop this sterilisation process has long been an option suggested by analysts for the ECB and will boost market liquidity.

"There’s been a lot of speculation recently about whether Mario Draghi would bring the bazooka to today’s meeting. As it turns out, he rolled up in a tank dressed like Rambo armed with everything from guns to grenade launchers," said Alpari market analyst Craig Erlam. "I don’t think anyone could have anticipated what was coming today, as Draghi and the ECB opted against choosing between the selection of monetary tools available and instead went for them all."

Stocks across the UK and Europe initially rallied to intra-day highs, with the German DAX breaking above 10,000 points for the first time ever, while the euro plunged to a four-month low against the dollar of USD1.3501, and the price of gold spiked almost 1% as investors scrambled for the safe haven asset.

However, UK stocks have since unwound all of the gains, while the euro was slightly higher against the dollar when the stock markets closed at USD1.3615.

The FTSE 100 ended down 0.1% at 6,813.49, and the FTSE 250 closed fractionally higher at 15,995.49.

"After a couple of hours to digest the information at hand it appears the market is viewing the ECB’s actions as having met expectations for this meeting," said CMC Markets market analyst Jasper Lawler.

The German DAX failed to hold above 10,000 points, ending up 0.2% at 9,947.83, while the French CAC 40 closed up 1.0% at 4,548.73.

After the European market close, US markets are higher, with the DJIA and the S&P 500 both up almost 0.4%.

London's AIM All-Share index underperformed its main market peers, closing down 1.5% at 800.18, after its biggest constituent by far, online fashion retailer ASOS lost nearly a third of its value in the wake of a profit warning.

ASOS closed down 31% after warning that its full-year pretax profit will be far worse than previously expected due to the continued strength of the pound and increased levels of promotional activity.

ASOS said that its full-year 2014 pretax earnings margin will be 4.5%, down from the previous guidance of 6.5%. Assuming the company's GBP1 billion sales target is achieved, this implies that full-year profit is likely to be about 30% lower than previously expected, said Liberum Capital.

While sales growth in its UK market was strong, much of the investment case for ASOS is based on its international expansion prospects, and international sales have been seriously hit by the recent strength in sterling which makes its products look more expensive abroad.

Smith & Nephew was the biggest FTSE 100 gainer again, as the market continues to price in a potential takeover offer emerging. Following a press report last week that Stryker was preparing an offer, which was denied by the US company, Bloomberg reported Thursday that fellow US medical device maker Medtronic Inc is considering a takeover bid. The news sent Smith & Nephew shares up 3.2%. The value of the company has now risen by almost 17% since the takeover rumour mill started spinning last Wednesday.

In the UK corporate calendar Friday, full-year results are due from telecommunications group KCOM, as well as brewer Fuller Smith & Turner, while interim results are scheduled from Scottish Investment Trust.

Friday's main economic event will be from the US, with the monthly non-farm payroll report due at 1330 BST. Economists are expecting the headline unemployment rate to rise slightly to 6.4% in May, from the 6.3% recorded in April, while an extra 218,000 are expected to have been added to the payroll, down from the very strong reading of 288,000 in April.

Ahead of the US data, German industrial production data is due ahead of the European equity market open, at 0700 BST, while UK trade balance data is due later in the morning at 0930 BST.

By Jon Darby; jondarby@alliancenews.com; @jondarby100

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