The European Central Bank has cut interest rates by a quarter of a percentage point, taking markets by surprise and providing a welcome boost to home-owners across the euro zone. The 0.25 per cent drop now brings interest rates to a record low of 0.25 per cent.

Pressure had been intensifying this week on the ECB to act, following a string of disappointing economic data, and signs that the euro zone could be entering a deflationary phase.

The euro, which has been appreciating in recent months, dropped sharply on the news this lunchtime, falling to a seven-week low. Despite low inflation, analysts had expected the ECB to wait until December to announce stimulus measures. It last cut the benchmark interest rate in May.

"We may experience a prolonged period of low inflation to be followed by gradual upward movements towards an inflation rate of below but close to 2 percent later on," ECB president Mario Draghi told a news conference

A number of economic indicators over the past few days have heightened the case for action at today’s monthly rate-setting meeting.

Inflation dropped sharply last month to 0.7 per cent – well below the ECB’s target level of 2 per cent – prompting fears that the euro zone could be entering a deflationary period.

On Tuesday the European Commission said it expected inflation to remain at its current levels until 2015. Its economic forecast also cut its growth outlook for the euro zone, citing the slowdown in emerging markets and the continuing adjustment process in member states as the main reason for the downward revision. The euro zone is now expected to grow 1.2 per cent next year, compared to 1.1 per cent forecast in May. A number of euro zone economies, including France and Spain, are predicted to miss deficit-reduction targets set by Brussels.

Economic data released yesterday presented a mixed picture. Markit’s purchasing managers’ index showed the pace of growth in euro zone businesses declined last month, but not as much as had been anticipated.

Activity in Italy and Spain declined, while Germany and the UK showed an increase. The jobs market also continued to deteriorate last month with companies cutting jobs at a faster pace last month than in previous months.

The news may come as a surprise to many analysts, who yesterday evening expected the ECB not to cut interest rates this month.

Marie Diron of Ernst and Young said that while an interest rate cut was possible, it was considered more likely the ECB would announce measures to be implemented from December. "The most effective measure that the ECB could take to diminish the risk of deflation would be to talk the euro down. We think that the euro is currently overvalued and the ECB expressing similar concerns could potentially push the currency down."