ECB cuts interest rate to 0.15%

 

BY THE PUNCH

The European Central Bank has lowered its benchmark interest rate to 0.15 per cent from 0.25 per cent in an effort to stimulate economic growth and avoid deflation in the eurozone.

According to the British Broadcasting Corporation, it has also reduced its deposit rate below zero, to -0.1 per cent, which means commercial banks will have to pay to lodge their money with the central bank, rather than receive interest.

The idea is to incentivise the banks to lend to businesses, thereby stimulating growth.

The ECB is the first of the “Big Four” central banks (the ECB, the US Federal Reserve, the Bank of Japan and the Bank of England) to do this.

Howard Archer, chief UK and European economist at IHS Global Insight said: “Despite being widely anticipated and in some quarters criticised for occurring too late, it is still a bold and unusual move by the ECB to take its deposit rate into negative territory.”

“There has to be considerable uncertainty as to how effective negative deposit rates will turn out to be,” he added.

It has been tried before in smaller economies. Sweden and Denmark, who are both outside the Single Currency, attempted to use negative rates in recent years with mixed results.

Analysts said in Sweden it had little discernable impact; in Denmark it did have the effect of lowering the value of the currency, the Krone, but according to the Danish Banking Association it also hit the banks’ bottom line profits.

The ECB’s president, Mario Draghi, also announced other measures.

Long term loans are to be offered to commercial banks at cheap rates until 2018. These loans would be capped at seven per cent of the amount that the individual banks in question lend to companies. Thus, the more the banks lend to companies, the more money they can borrow cheaply from the ECB.

It’s also doing preliminary work that would lead to buying bundles of loans that are made to small businesses in the form of bonds. This is being seen as a step towards providing companies with credit through the financial markets.

Mr Draghi said the ECB’s policymakers unanimously agreed to consider more unconventional measures to boost inflation if it stays too low. The ECB stopped short of instituting a large asset-buying programme like the quantitative easing undertaken by the US Federal Reserve. However. Mr Draghi insisted that more would be done, if necessary.

“Are we finished? The answer is no. We aren’t finished here. If need be, within our mandate, we aren’t finished here.” he said.

Mr Draghi said that the whole package of measures was aimed at increasing lending to the “real economy”.

“Now we are in a completely different world,” he said.

Even though some of the measures, like the more to negative rates on deposits, were expected European shares moved higher on the ECB announcements.

The benchmark German DAX 30 index jumped about the 10,000 level for the first time. The CAC 40 in Paris gained 0.77 per cent shortly after the ECB’s comments.

Meanwhile, the euro plunged to $1.3558, its lowest level in four months.

Although, the danger of deflation in the eurozone is limited, the ECB is concerned that growth is very sluggish and bank lending weak — both of which could potentially derail the fragile economic recovery.

The eurozone economy is only growing at 0.2 per cent. Consumer spending, investment and exports are all growing at a slower pace than this time last year.

Inflation in the Eurozone fell to 0.5 per cent in May, down from 0.7 per cent in April. This is well below the European Central Bank’s 2 per cent target.

If the eurozone slips into deflation, consumers would spend even less because they’d expect prices to fall in future months. For the same reason investors stop investing.

Growth would then grind to a halt and demand would be severely constrained. The large debts amassed by the eurozone’s countries, companies and banks would take longer and be harder to pay off.

Unemployment, which is already at nearly 12 per cent in the eurozone, and much higher in places like Spain, Portugal and Greece, would get even worse.