By: John O’Donnell
June 6, 2014
The European Central Bank cut interest rates to record lows on Thursday, launched a series of measures to pump money into the sluggish euro zone economy, and pledged to do more if needed to fight off the risk of Japan-like deflation.
For the first time, the ECB will charge banks for parking funds at the central bank overnight in an attempt to force them to lend to small- and medium-sized businesses.
The measures were also aimed at easing pressure on the strong euro, which is threatening economic recovery and importing disinflation.
Euro zone inflation has been stuck in what Draghi has called “the danger zone” below 1 percent since October, mainly because of weaker commodity and food prices, but also because of wage and other adjustments in euro zone crisis countries.
The bank stopped short of full-fledged quantitative easing (QE) – printing money to buy assets – but ECB President Mario Draghi said more action would come it necessary. Asked why the ECB had not gone ahead with QE, he told a news conference:
“We think (what we’ve done is) a significant package. Are we finished? The answer is no. We aren’t finished here. If need be, within our mandate, we aren’t finished here.”
RBS economist Richard Barwell said this comment would fuel market expectations for more action:
“We doubt the knee-jerk response to further bad news will be ‘give the June package more time’; expectations of a broad-based asset purchase programme will rapidly start to build,” he said.
Draghi outlined a four-year 400 billion euro ($544.86 billion) scheme giving banks that have been holding back credit due to looming stress tests an incentive to increase lending to businesses in the euro zone.
“Now we are in a completely different world,” Draghi said, citing “low inflation, a weak recovery and weak monetary and credit dynamics”.
The package, adopted unanimously, was aimed at increasing lending to the “real economy”, he said.
Other steps included extending the duration of unlimited cheap liquidity for euro zone banks, injecting about 170 billion euros by stopping tenders that withdrew funds spent on past government bond purchases, and preparing for possible future purchases of asset-backed securities to support small business.
Projections published by the ECB showed inflation would be just 0.7 percent this year, 1.1 percent next year and 1.4 percent in 2016, a downward revision and far below the ECB’s target of below-but-close-to 2 percent.
“If required, we will act swiftly with further monetary policy easing,” he said, adding that the policy-setting Governing Council was unanimous in its commitment to use unconventional instruments if needed “to further address risks of too prolonged a period of low inflation”.
Most of the measures had been widely anticipated. The euro initially fell to a four-month low of $1.3505 after Draghi’s statement before recovering to trade above $1.3600, slightly up on the day. European shares rose and yields on the government bonds of stressed euro zone countries fell.
FRANCE HAPPY, GERMANY SILENT
French President Francois Hollande, who has been calling for months for ECB action to weaken the euro’s exchange rate, which Paris argues is holding back economic recovery, welcomed the central bank’s decision.
The International Monetary Fund, which has also pressed the ECB to take robust action, welcomed Thursday’s announcements a “very proactive stance”.
German Chancellor Angela Merkel declined comment, noting that the ECB took its decisions independently of governments. Her finance minister, Wolfgang Schaeuble, said low interest rates were not a long-term solution.
Low rates are unpopular in Germany, Europe’s biggest economy, because they are seen as penalizing savers.
Conservative German economist Hans-Werner Sinn of the Ifo institute said the ECB’s moves smacked of desperation and would not work.
“This is a desperate attempt, with ever cheaper money and penalty rates on deposits, to shift capital flows to southern Europe in order to stimulate growth there,” he said.
Draghi said interest rates would stay low for a prolonged period but after Thursday’s cut, he omitted a previous regular line that they could go lower. He added that “for all practical purposes” interest rates had reached the bottom.
Asked how long it would take for the measures to work their way though into the economy, he said: “Most likely we will see immediate effects in the money markets and we will see delayed effects in the real economy attributable to this programme … It will probably take three or four quarters.”
The ECB lowered the deposit rate to -0.1 percent. It cut its main refinancing rate to 0.15 percent, and the marginal lending rate – or emergency borrowing rate – to 0.40 percent.