ECB cuts rate to record-low 0.5%; chief hints at bolder moves

The Washington Post, AP

Europe is a mess, with a handful of Southern European countries in depression and many of the other nations on the continent in recession. Inflation has been exceptionally low, even in economically strong Germany.

So it would be a good time for “Super Mario” Draghi to come to the rescue, but the European Central Bank president didn’t quite deliver on Thursday.

The bank cut target interest rates by a quarter of a percentage point, leaving the ECB’s key interest rate at a record low of 0.50 percent, but that wasn’t quite the salve that the 27 percent of Spanish workers who are unemployed might hope for.

Yet in Draghi’s news conference following a meeting of its rate-setting council in Slovakia, it became clear that the central bank is starting to weigh some bigger and bolder things to try to get a monetary policy in place that will match the moment for Europe.

And out of concern that Europe’s financial industry is lending too cautiously, the ECB also extended its offer of unlimited, cheap loans to banks at least through July 2014. Previously, the ECB had planned to end the program as soon as this July.

To jolt banks into lending more freely, Draghi said the ECB would even consider charging banks to deposit funds with the ECB. Since 2008, the ECB has reduced the interest rate it pays to banks on deposits from 3.25 percent to zero, creating an incentive for them to lend that money out instead.

Together, the measures announced Thursday by the ECB amounted to a grim recognition: Despite record-low interest rates, European banks still remain risk-averse, while some companies don’t want to risk borrowing in a slow economy.

Draghi also delivered a warning to Europe’s political leaders: Extraordinary actions by the central bank will not be enough to heal the region’s economy. Governments need to accelerate efforts to cut excessive regulations and make Europe a more hospitable place for business.

The economy of the 17 European Union countries that use the euro certainly needs a boost. The ECB says the eurozone will shrink 0.5 percent for all of this year, and unemployment is at 12.1 percent.

Many economists say clogged lending to small companies means Thursday’s cut won’t do much good. Marie Diron, senior advisor to Ernst & Young, said her assessment was “slight disappointment that the ECB has done the bare minimum.” At this point, how low rates can go is “a relatively technical point” compared with the bigger issue of getting low rates transmitted to companies, she said.

Draghi had only a sketchy proposal Thursday of how to solve the problem, saying that ECB officials are working with the European Union’s executive commission and the European Investment Bank lending agency on a strategy to ease lending beyond lower rates. The idea under discussion is to create a market for securities, where loans to businesses would be packaged together and sold to investors — a step that could free up more money for loans.

It took a while, but the ECB has finally reached a point that the Federal Reserve hit in December 2008 and the Bank of England hit in March 2009: the zero lower bound. Each bank defines differently the lowest it is willing to go in its short-term interest rate target (for the Fed that is roughly 0.15 percent, for the Brits it is 0.5 percent).

But with the ECB’s deposit rate now at zero, the eurozone has joined the other Western central banks in an environment in which traditional, plain vanilla cutting of short-term interest rates isn’t an option.

It is clear that there is a strong current of thought on the ECB’s governing council that they will need to do significantly more to ease policy, and soon.

“We will look at all the incoming data and stand ready to act if needed,” Draghi said Thursday.

What will that mean in practice?

On interest rate policy, the ECB appears open to moving in a direction that the other major central banks have not. A reporter asked Draghi if the central bank would consider a “negative deposit rate,” essentially charging banks for the privilege of parking money at the ECB. The idea is that if they paid some penalty for sitting on reserves, banks would have that much more incentive to lend it out to borrowers instead.

It would be a step with few precedents (one was a step by the Swedish Riksbank in 2009, which soon reversed its minus 0.25 percent deposit rate). There are plenty of technical challenges involved, including that banks may just keep more money in the form of paper bank notes in their vaults as opposed to reserves on deposit electronically, in order to try to avoid the fee.

But the concept is clearly on the table in Europe. “We will look at this with an open mind,” Draghi said.

  • http://www.facebook.com/peter.jury.50 Peter Jury

    They’ve been “kick-starting” the economy for five years now, since when the rate was nearly 5%. If we were talking about a motorbike, your leg would have dropped off a long time ago! These bureaucrats really seem to be a few tinnies short of a six-pack when it comes to understanding economics: if you ask me, politicians in general haven’t a clue. Let’s face it: if folding towels at Selfridges qualifies you to be the UK Chancellor of the Exchequer, then what hope have we got…? (And no offence intended to hardworking shop assistants everywhere, who probably know more about real economics than any politician!). I firmly believe they should address the crisis with greater professionality. For example, by engaging the services of the Orlando Bisegna Index, some US counties have resolved deficit problems and business failures, and reduced unemployment. The Orlando Bisegna Program has arisen from their development of the Orlando Bisegna Index, a unique index based on 206 diverse indicators that measures the intensity of the economic crisis in the G20 countries and other Euro countries. Given that none of the policies adopted so far seem to be working, and now that “Expansionary Austerity” has been shown to be nothing but a pipe dream, surely a fresh approach is needed.