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Categorized | Banks, Currencies, Economy

ECB poised to cut main interest rates

Posted on May 30, 2014


The European Central Bank is next week poised to cut interest rates and boost lending to credit-starved smaller businesses in its battle to head off the threat of Japanese-style deflation.

The ECB is expected to go where no central bank has gone before and lower one of its interest rates below zero at its rate-setting meeting on Thursday. The move contrasts with the British mood, where the Bank of England is considering raising rates as its recovery gains pace.

    Senior ECB officials have hinted that they will also present measures to tackle the plight of the eurozone’s struggling SMEs to counter what ECB president Mario Draghi this week dubbed a “pernicious negative spiral” of low inflation and tight borrowing constraints.

    Jens Weidmann, Bundesbank president, is planning to support the ECB’s proposal to ease constraints on smaller businesses in more troubled parts of the currency bloc, according to a senior European central banker, but his vote for rate cuts is thought to be more finely balanced.

    The ECB is expected to announce a fixed-rate offer of cheap central bank funds, often referred to as a longer-term refinancing operation, according to two people familiar with the matter. Under the LTRO, banks could borrow as much as they wanted from the central bank in the form of loans with maturities of a number of years.

    The ECB has used LTROs to pump €1tn into the eurozone’s financial system, though the amount offered this time could be lower as banks’ demand for central bank cash has waned.

    People familiar with the matter say the fixed rate will depend on banks’ commitments to support credit creation in certain areas. The LTRO is expected to ape the design of the BoE’s Funding for Lending Scheme, which allows banks to shrink their balance sheets and still benefit from the cheap loans, so long as the level of contraction is not too large.

    Most analysts expect a cut of 10 or 15 basis points to the ECB’s main refinancing rate, now 0.25 per cent, to be matched by a cut to its deposit rate, which stands at zero. A move into negative territory in effect imposes a levy on reserves held at the ECB – a change that policy makers hope will spur lending from banks in the region’s core to those in the periphery, as well as weakening the euro.

    After more than six months of talks, the ECB has been expected to act in June since Mr Draghi said in early May that rate-setters were “comfortable with acting next time”. The ECB president said after this month’s policy vote there was consensus within the ECB council over “dissatisfaction about the projected path of inflation”.

    At 0.7 per cent, eurozone inflation is worryingly low and stands at less than half the ECB target of below but close to 2 per cent. The central bank will set out projections for inflation at Thursday’s meeting, with the forecasts for 2016 set to determine whether or not the governing council’s more hawkish members back rate cuts.

    The ECB president signalled the central bank would take action to boost lending on Monday, saying credit constraints were “putting a break on the recovery in stressed countries, which adds to disinflationary pressures”.

    Lending to businesses around the bloc has continued to fall despite early signs of an economic recovery. Conditions have been particularly tight for smaller companies in peripheral countries.

    The ECB declined to comment.