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Categorized | Economy

Blow for ECB as wider loan rates hit south

Posted on March 31, 2013

A logo of the European Central Bank at its headquarters in Frankfurt©AFP

Divergences across the eurozone in interest rates paid by businesses on bank loans have reached record highs, despite European Central Bank action to prevent Europe’s monetary union fragmenting.

Widening differences in borrowing costs, shown in an analysis by Goldman Sachs, highlight how ECB measures have prevented a catastrophic eurozone break-up – but failed to ease crippling credit conditions in much of the region’s southern periphery, where economic growth prospects remain bleak.

Eurozone fragmentation

Eurozone fragmentation

    Since mid-2012, the spread between yields on Spanish and Italian sovereign 10-year debt and the German equivalent has narrowed significantly. Goldman Sachs’ interest rate divergence indicator – measuring cross-border variations in interest rates charged by eurozone banks on a variety of business loans – also dipped initially.

    But the indicator has since risen again and reached a record of 3.7 percentage points in January, indicating companies in southern Europe were paying significantly higher interest rates than northern rivals.

    “Market segmentation remains, divergence in bank lending rates persists and, as a result, immediate growth prospects in the periphery are bleak,” said Huw Pill, European economist at Goldman Sachs, who was previously a senior monetary policy official at the ECB in Frankfurt.

    The results will disappoint Mario Draghi, the ECB’s president, ahead of the meeting of its governing council on Thursday. They highlight the challenge the ECB faces in ensuring low official interest rates feed through into lower borrowing costs, especially for job-creating small businesses in countries such as Italy and Spain.

    In much of the eurozone periphery, small companies depend heavily on bank finance. Contagion effects from the crisis in Cyprus – not yet reflected in the Goldman Sachs indicator – may have intensified further the financing pressures they face.

    Since taking office in November 2011, Mr Draghi has battled against the eurozone’s financial fragmentation – first by injecting more than €1tn in cheap three-year loans into the financial system and then by pledging last July to do “whatever it takes” to ensure the eurozone’s integrity.

    Reasons for the latest widening in interest rates paid by business are not obvious – but could include heightened tensions ahead of Italy’s elections in February, a further weakening in banks’ finances, or a reversal of the initial improvement in financial market sentiment that followed ECB policy actions.

    Worries about the depth of the recession hitting the eurozone’s south have fuelled expectations that the ECB will cut official interest rates further. The ECB’s main policy rate has been held at 0.75 per cent since last July.