ECB cuts interest rates to support the worsening euro economy, mulls future action

May 2, 2013
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Euro Crunch
May 2, 2013

Update 9:30 AM ET: The European Central Bank cut its target rate from 0.75% to 0.5%, in a long-demanded and widely expected move. That’s the first interest rate cut since July 2012. The central bank also surprisingly cut the marginal lending rate–the rate at which banks can borrow overnight funds–from 1.5% to 1%. Banks rarely use the marginal lending facility, even at low rates, except in times of emergency.

While the ECB and its president, Mario Draghi, have taken big steps to protect the euro currency and stave off a collapse of the monetary union, they have done little to prevent the euro area economy from falling deeper into recession. That recession has been severe in the European periphery, and continues unabated.

However, it’s unlikely that a rate cut alone will be enough to satisfy markets, because the effects of a rate cut are unlikely to translate into looser credit for individuals and small businesses. Many analysts expected more–particularly, some direct support to small businesses. But as Societe Generale’s head of global FX strategy, Kit Juckes, tweeted, “So far, rate cut but no bunny.”

At a press conference held after the monetary policy decision, Draghi revealed that the ECB is in fact looking into options to help small businesses, options that would be unprecedented for a bank that has been hesitant to adopt measures like quantitative easing.

First, he mentioned that the ECB could, in the future, adopt a program that would allow banks to borrow from its coffers by posting collateral comprised of asset-backed securities–in this case, packages of loans to non-financial institutions. Alternatively, he mentioned that the European Investment Bank might be able to directly buy up packages of “SME loans, residential mortgages, and other types of loans.”

Then again, Draghi offered little reassurance for small- and medium-sized enterprises that need credit now. “Our thinking is very much in the preliminary stage given the complexity of the issue,” he told reporters. “There are many options [to consider] before me being able to give you an answer.”

The ECB also stands ready to lower the deposit rate–the interest paid to banks that park their money at the ECB–beyond its current level of 0%. That would effectively charge banks money for not using their cash, pushing them to use it elsewhere. But concerns about the unintended consequences of this policy have held the ECB Governing Council back from moving forward.

However the ECB is “frustrated” by the lack of progress being made by policymakers and the fact that banks aren’t taking more risk. “Monetary policy by the ECB has been extraordinarily accommodative throughout,” Draghi argued. “Many of the problems that we see today in competitiveness in labor markets in the tax area have nothing to do with monetary policy, neither can be fixed by monetary policy.”

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