The European Central Bank cut its main interest rate to a new record low on Thursday, and will buy up bonds for the first time in a bid to stem the euro zone's economic decline and shore up shaky markets.

The decision is the first step on a path of quantitative easing, although the ECB stopped short of the massive asset purchase programs being followed by counterparts including the U.S. Federal Reserve and the Bank of England.

The ECB plans to spend about 60 billion euros ($80 billion) buying covered bank bonds -- securities issued by banks and backed by mortgages or other loans -- but did not rule out expanding the program into other types of assets down the track.

As well, the ECB will double the maximum term of its loans to banks to 12 months and prolong easier rules on the types of assets which can be used as security for loans in a three-pronged package of steps to complement its rate cuts.

ECB President Jean-Claude Trichet said the latest 25 basis point cut, which took the main refinancing rate to 1.0 percent, as expected by markets and economists, left benchmark credit costs at an appropriate level.

Still, he said this was not necessarily the lowest point of the cycle which has slashed rates by 3.25 percentage points in eight months.

(For graph, click http://graphics.thomsonreuters.com/RNGS/MAY/RATE.jpg)

We have not decided today that the new level of our policy rates was the lowest level, that we could never cross whatever future circumstances could be, Trichet told a news conference after the decision.

He also declined to commit the ECB to keep rates at a low level for any particular period and said the central bank would unwind its efforts to stimulate the economy when needed.

Several policymakers have said they are unwilling to go below 1 percent for practical and psychological reasons, although Trichet said all decisions taken on Thursday were unanimous.

The ECB's decision to buy covered bonds, which comes after months of deliberation and public disagreement among its 22 policymakers about how far to go to support growth, pushed the euro to a fresh one-month high against the dollar.

Euro zone government bond futures pared losses and the 2-10 year yield curve steepened to levels not seen since at least 1999.

Bank of England policymakers left UK rates unchanged at 0.5 percent earlier on Thursday, as expected, and increased the size of their asset purchase program by 50 billion pounds ($76 billion).

Barclays Capital economist Julian Callow said the ECB's decision could pave the way for more radical asset purchases down the track. Clearly this 'credit easing' could start to open the door for fully fledged QE from the summer, if the inflation outlook were to become more negative, he said.

Barclays estimates the size of the euro-denominated covered bond market at about 1.5 trillion euros, with the largest markets in Germany and also Spain.

BUDDING GREEN SHOOTS

Trichet said the ECB would announce details of its bond purchase plan at its June meeting, when it will also revise down GDP projections for the 16-nation region.

Although some data suggested the economy's decline was slowing and the second quarter of 2009 would probably not be as bad as the first, these green shoots were still tentative.

We were in a free fall, but now we see there is a stabilization. As I said, we've to be realistic, it is a stabilization at a low level and we continue to be in negative territory, Trichet said.

Better-than-expected euro zone business and consumer sentiment this month, alongside improvements in closely-watched forward-looking indicators such as PMI and business activity data have sparked hopes that the worst of the recession is over.

But the European Commission this week predicted the euro zone economy would shrink 4 percent this year and 0.1 percent next year, well below the ECB's current worst-case scenarios.

Trichet said it was likely the June ECB staff projections would be similar to those from the Commission and the International Monetary Fund.

In a further twist to its decision, the ECB kept the overnight deposit rate, which is acting as a floor for money markets, at 0.25 percent, narrowing the gap between its policy rates instead of cutting the lowest of these to zero.

The marginal lending rate was cut by 50 basis points, to 1.75 percent.

The European Investment Bank will also be allowed to join commercial banks in tapping ECB funds at liquidity operations, helping to support the extra demand for EIB funds.

(Writing by Krista Hughes and Marc Jones; editing by David Stamp)

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