Tags: ECB | Rate | Cut | europe

ECB Lays Ground for Rate Cut but Impact Could Be Minor

Wednesday, 27 Jun 2012 12:57 PM

 

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There is nothing to stop the European Central Bank cutting interest rates further, a senior policymaker said on Wednesday, adding to expectations it could act as soon as next week to counter dimming growth prospects and help tackle the eurozone crisis.

Executive Board member Peter Praet's intervention followed his colleague Benoit Coeure, who said last week cutting rates was an option and one that would be discussed at the ECB's July 5 meeting.

"There is no doctrine that interest rates cannot fall below 1 percent," Praet told German daily Financial Times Deutschland in an interview. "They (rate cuts) are justified if they contribute to guaranteeing price stability in the medium term."

A Reuters poll found 48 out of 71 analysts tipped the central bank to cut rates next week, most of them forecasting a 25 basis point cut to 0.75 percent.

Praet's comments came only three weeks after ECB President Mario Draghi had said that rate cuts would have only limited impact due to malfunctioning markets. Until recently, analysts doubted the bank would ever push rates below their record low of 1.0 percent, where they have stuck since December last year.

Now it is increasingly clear that such doubts will not stop the ECB.

"This is another signal that they're warming up to a rate cut," said Danske Bank economist Anders Moller Lumhortz, who expects the refinancing rate to be cut by 25 basis points to 0.75 percent in July and remain low for a long time.

"It's a signal that the ECB will do more to support the economy," Lumhortz said.

Praet himself warned against expecting too much from a rate cut, saying: "Rate cuts always have an impact, even if it's limited."

An important effect would be an immediate reduction in the rates banks pay for the money they have borrowed from the ECB, including the 1.02 trillion euros they took in the twin 3-year LTRO operations.

For that money, they now pay 10.2 billion euros in interest annually, which would be cut by 2.5 billion were the main policy rate reduced by a quarter point. Spanish, Italian and French banks took up the money most heavily.

There is no sign that the ECB will heed to calls from Spain and others to revive its bond-buying program to push eurozone borrowing costs lower.

IMPACT QUESTIONED

Price data released on Wednesday left the ECB with room to cut. Annual inflation in the eurozone's largest economy, Germany, eased more than expected to 1.7 percent in June from 1.9 percent in May, helped by falling oil prices.

"The data add to the already strong case for ECB action at next week's meeting," said Berenberg economist Christian Schulz.

Draghi said recently he could see no sign of inflationary pressure anywhere in the eurozone.

At the same time, the ECB does not expect lower interest rates to solve the 17-nation bloc's problems. Governing Council member Josef Bonnici said on Tuesday that cutting rates would have a limited impact on the eurozone economy.

"Interest rates are already very low, so the impact of even lower interest rates is ... limited," Malta's Bonnici told Reuters.

Two other Governing Council members, Austria's Ewald Nowotny and Slovakia's Jozef Makuch, have said they could imagine the deposit rate going to zero. The Council is made up of the six Executive Board members and the 17 national central bank chiefs.

"There is a concern this will emphasize the fact that the ECB's policy options are effectively exhausted," Societe Generale economist James Nixon said of a rate cut.

"My concern is that this may actually undermine confidence rather than have a positive effect - the ECB is effectively clutching at straws."

DEPOSIT RATE

Cutting the deposit rate - the interest the ECB gives banks for their overnight deposits at the central bank - from 0.25 percent would be at least as important as lowering the main refinancing rate, analysts said.

Banks have regularly parked close to 800 billion euros at the ECB's overnight facility following the second of the twin LTROs on Feb. 28, money that the ECB would rather see circulating more in the economy.

"Whatever arguments they've used in the past have now been overcome by the desire to reduce the incentives to use the deposit facility," Nixon said.

"There is no point in just cutting the refinancing rate, it has to be a cut in the deposit rate."

He also said that a rate cut could inflict more pain on money markets, which are already barely functioning.

"There is a concern that if you go too low, you end up with an interest rate that doesn't even cover the operating costs of money market funds," Nixon said, but added that the ECB seems to have decided that the merits of cuts outweigh the drawbacks.

© 2014 Thomson/Reuters. All rights reserved.

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