THE European Central Bank cut interest rates for the first time in 10 months yesterday, driven to act by an economy wallowing in recession and freed to do so by sharply falling inflation.

The ECB lowered its main interest rate by a quarter point to a new record low of 0.50 percent in response to a drop in inflation well below its target level, and rising unemployment.

The cut was widely expected, after ECB President Mario Draghi said last month the bank stood ready to act.

Economic data over the last month have aided the case for action, with unemployment at a record high in April, when inflation saw its biggest monthly drop in over four years, to 1.2 percent.

"The ECB is playing it safe, even though they know the effect is likely to be limited," Nordea analyst Anders Svendsen said of the cut.

"The key for the market is the tone. If the ECB comes out with other measures as well to help SME (small- and mid-sized enterprise) lending that will be positive but if they say the cut was all they had, I think there will be disappointment."

The euro rose to US$1.3191 and German 10-year government bond futures edged higher after the decision.

The sharp drop in inflation, from 1.7 percent in March, pressured the ECB to cut rates to honor its mandate to deliver price stability, which it defines as inflation close to but below 2 percent.

The sudden slump in price pressures has also raised the possibility of the ECB having to look at policy tools beyond interest rates to counter any further slide in inflation.

"Ultimately, we think the ECB will have to purchase private-sector assets in order to fix the transmission mechanism," said Andrew Bosomworth at PIMCO, the world's largest bond fund.

The ECB wants to improve the transmission of its monetary policy so its low rates reach all of the eurozone.

The bloc's south is not benefiting to the same extent as the north from the ultra-low rates. If they are lending at all, banks there are charging companies and households more for loans than their peers in the north because of higher funding costs and credit risks.

The ECB has repeatedly voiced its concern about the impact this has on lending to SMEs, which have little alternative to bank funding and are a key engine for growth in the eurozone.