ECB cuts rates for second month running
by Daniel Mason
08 December 2011
The European Central Bank has announced new measures to boost bank liquidity and cut its main interest rate for the second month in succession in a bid to spark life into the eurozone economy, which has been widely predicted to fall back into recession. But president Mario Draghi dashed hopes that the ECB would radically increase the bank's bond purchase programme to ease the strain on struggling governments' borrowing costs.
As widely predicted by markets and commentators, the ECB reduced its main interest rate from 1.25 per cent to 1 per cent, the same historic low seen in summer 2009 and the second 25 basis point cut since Draghi took over the presidency from Jean-Claude Trichet in October. The Italian admitted, however, that the decision was not unanimous, with some members of the bank's governing board preferring to leave rates unchanged.
The ECB also adopted new non-standard measures to increase liquidity in the European banking sector. It will make unlimited three-year credit available to banks, accept a greater range of collateral for emergency loans, and cut the reserve ratio that banks have to deposit with the ECB from two to 1 per cent in January. Member states' central banks will be able to accept bank loans in exchange for liquidity at their own risk.
Draghi said market conditions continued to "dampen economic activity in the euro area" which would pick up "very gradually" next year following a decline the last quarter of 2011. Gross domestic product is forecast to grow by between -0.4 per cent and 1 per cent in 2012, rising to between 0.3 per cent and 2.3 per cent in 2013. Inflation would remain above 2 per cent for several months, he said. The bank aims for close to but below 2 per cent.
But Draghi's refused to commit the ECB to increased purchasing of government bonds or lending money to troubled countries via the International Monetary Fund. The European Union treaty does not allow the ECB to print money to plug government deficits and Draghi said: "We shouldn't try to circumvent the spirit of the treaty, not matter what the legal trick is." He appeared to backtrack from comments he made last week, when he hinted that the ECB might take more aggressive policy action to tackle the crisis on the condition that eurozone countries agreed to a "fiscal compact" with strict rules to curb budget deficits and public debts.
Draghi said he was "puzzled" by the reaction to his comments, adding: "We have our own views, we have collaborated in the process, but the responsibility is with the leaders." However, Sony Kapoor, managing director of the economic think-tank Re-Define, said the future of the euro area "may fall through the cracks between institutional rigidities of the ECB on the one hand and petty EU politics on the other". He said the strong support to the banking sector was "unexpected" but that division in the ECB over the relatively minor point of whether to cut the interest rate "does not augur well for future support for more substantial actions".
He added: "The fact remains that even with all these additional non-standard measures to support banks, it will be well-nigh impossible for anyone in the real economy in Italy and Spain to be able to borrow anywhere close to the ECB policy rate. Monetary policy transmission is broken and cannot be restored till confidence is restored."
Meanwhile, the Centre for Economics and Business Research's senior economist Tim Ohlenburg said the cut "may ease the burden of debt repayment slightly if it actually feeds through to borrowers. But in the prevailing climate of uncertainty it is unlikely to spur consumption and investment as consumers fret about unemployment and firms about the economic outlook. This scenario leaves classic monetary policy impotent.
"The more important decision that the ECB has to make is whether to prop up sovereign debt or leave the eurozone member states to sort out their fiscal mess alone. Mario Draghi's hint that the ECB may step in to buy time for a restructuring of economic and fiscal governance if leaders agree a credible solution is important. It offers a chance to hold the market at bay for a limited period while a framework for debt reduction is agreed."
Given that the decision to cut interest rates was not unanimous makes a further reduction in January unlikely, according to Howard Archer, chief European Economist at IHS Global Insight. "At the same time though Draghi did not rule out interest rates going below 1 per cent, merely stating that the ECB does not 'pre-commit'."
But he added: "We think it is very possible that the ECB will take interest rates down further and expect to see a 25 basis point cut to 0.75 per cent in the first quarter, very possibly in February. Furthermore, we think interest rates could well come down to 0.50 per cent. This reflects our belief that the ECB is likely to see economic contraction through to mid-2012. We suspect that the ECB staff's new eurozone GDP growth forecasts are not pessimistic enough, even though they have been cut markedly."
As widely predicted by markets and commentators, the ECB reduced its main interest rate from 1.25 per cent to 1 per cent, the same historic low seen in summer 2009 and the second 25 basis point cut since Draghi took over the presidency from Jean-Claude Trichet in October. The Italian admitted, however, that the decision was not unanimous, with some members of the bank's governing board preferring to leave rates unchanged.
The ECB also adopted new non-standard measures to increase liquidity in the European banking sector. It will make unlimited three-year credit available to banks, accept a greater range of collateral for emergency loans, and cut the reserve ratio that banks have to deposit with the ECB from two to 1 per cent in January. Member states' central banks will be able to accept bank loans in exchange for liquidity at their own risk.
Draghi said market conditions continued to "dampen economic activity in the euro area" which would pick up "very gradually" next year following a decline the last quarter of 2011. Gross domestic product is forecast to grow by between -0.4 per cent and 1 per cent in 2012, rising to between 0.3 per cent and 2.3 per cent in 2013. Inflation would remain above 2 per cent for several months, he said. The bank aims for close to but below 2 per cent.
But Draghi's refused to commit the ECB to increased purchasing of government bonds or lending money to troubled countries via the International Monetary Fund. The European Union treaty does not allow the ECB to print money to plug government deficits and Draghi said: "We shouldn't try to circumvent the spirit of the treaty, not matter what the legal trick is." He appeared to backtrack from comments he made last week, when he hinted that the ECB might take more aggressive policy action to tackle the crisis on the condition that eurozone countries agreed to a "fiscal compact" with strict rules to curb budget deficits and public debts.
Draghi said he was "puzzled" by the reaction to his comments, adding: "We have our own views, we have collaborated in the process, but the responsibility is with the leaders." However, Sony Kapoor, managing director of the economic think-tank Re-Define, said the future of the euro area "may fall through the cracks between institutional rigidities of the ECB on the one hand and petty EU politics on the other". He said the strong support to the banking sector was "unexpected" but that division in the ECB over the relatively minor point of whether to cut the interest rate "does not augur well for future support for more substantial actions".
He added: "The fact remains that even with all these additional non-standard measures to support banks, it will be well-nigh impossible for anyone in the real economy in Italy and Spain to be able to borrow anywhere close to the ECB policy rate. Monetary policy transmission is broken and cannot be restored till confidence is restored."
Meanwhile, the Centre for Economics and Business Research's senior economist Tim Ohlenburg said the cut "may ease the burden of debt repayment slightly if it actually feeds through to borrowers. But in the prevailing climate of uncertainty it is unlikely to spur consumption and investment as consumers fret about unemployment and firms about the economic outlook. This scenario leaves classic monetary policy impotent.
"The more important decision that the ECB has to make is whether to prop up sovereign debt or leave the eurozone member states to sort out their fiscal mess alone. Mario Draghi's hint that the ECB may step in to buy time for a restructuring of economic and fiscal governance if leaders agree a credible solution is important. It offers a chance to hold the market at bay for a limited period while a framework for debt reduction is agreed."
Given that the decision to cut interest rates was not unanimous makes a further reduction in January unlikely, according to Howard Archer, chief European Economist at IHS Global Insight. "At the same time though Draghi did not rule out interest rates going below 1 per cent, merely stating that the ECB does not 'pre-commit'."
But he added: "We think it is very possible that the ECB will take interest rates down further and expect to see a 25 basis point cut to 0.75 per cent in the first quarter, very possibly in February. Furthermore, we think interest rates could well come down to 0.50 per cent. This reflects our belief that the ECB is likely to see economic contraction through to mid-2012. We suspect that the ECB staff's new eurozone GDP growth forecasts are not pessimistic enough, even though they have been cut markedly."
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