European Central Bank weighs rate cut to stimulate stalling economy
Published Wednesday, May 1, 2013 7:27AM EDT Last Updated Thursday, May 2, 2013 12:18PM EDT
In this file picture, the Euro sculpture is photographed in front of the European Central Bank ECB in Frankfurt, central Germany on Sept. 2, 2009. (AP / Michael Probst, File)
FRANKFURT, Germany -- The European Central Bank cut its key interest rate to a record low 0.50 per cent Thursday and announced other measures to spur lending and help lift the euro area out of a stubborn recession.
The bank also extended its offer of unlimited, cheap loans to banks at least through July 2014. Previously, the ECB had planned to end the program as soon as this July
The ECB lowered its benchmark refinancing rate from 0.75 per cent, as expected, at a meeting of its rate-setting council in Bratislava, Slovakia.
ECB President Mario Draghi indicated he was prepared to flex its muscles further in the face of high and rising unemployment and growing evidence that Europe's economy is getting weaker. He said the ECB stood "ready to act if needed."
Eager to jolt banks into lending more freely, Draghi said the ECB would even consider charging banks to deposit funds with the ECB by lowering their deposit rate into negative territory from the current zero per cent. That would make room to cut the refinancing rate again -- since the bank likes to keep some space between the two rates.
Together, the measures announced by the ECB Thursday amounted to a grim recognition: despite record-low interest rates, European banks still remain cautious about lending to consumers and businesses, while some companies don't want to risk borrowing in a slow economy.
Draghi also delivered a warning to Europe's political leaders: extraordinary actions by the central bank will not be enough to heal the region's economy. Governments need to accelerate efforts to cut excessive regulations and make Europe a more hospitable place for business.
The economy of the 17 European Union countries that use the euro certainly needs a boost. The ECB says the eurozone will shrink 0.5 per cent for all of this year and unemployment is at 12.1 per cent.
Companies across the region are hurting. Auto sales slumped in the first quarter, hitting first-quarter profits at carmakers such as Daimler, Volkswagen and BMW.
BMW said Thursday that "we do not expect to receive a great deal of impetus from most European markets over the next few months."
Many economists say clogged lending to small companies meant Thursday's cut will not do much good. Marie Diron, senior advisor to Ernst & Young, said her assessment was "slight disappointment that the ECB has done the bare minimum."
At this point, how low rates can go is "a relatively technical point" compared to the bigger issue of getting low rates transmitted to companies, she said.
Draghi had only a sketchy proposal Thursday of how to solve the problem, saying that ECB officials were working with the European Union's executive commission and the European Investment Bank lending agency on a strategy to ease lending beyond lower rates. The idea under discussion was to create a market for securities backed by loans to businesses, a step that could free up more money for loans.
Market reaction to the ECB decision was muted as the interest rate cut had already been priced in by investors. However, the euro tumbled against the dollar, down almost 1 per cent to $1.306, after Draghi said he would not rule out taking the rate the bank offers lenders for deposits to below zero. This would mean a bank would have to pay to hold money with the ECB.
Most economists had expected a cut after recent economic indicators gave alarming signs that the ECB's prediction for a recovery by year-end might not be coming true. Draghi stuck with that prediction but said there were risks that "could dampen confidence and delay the recovery."
He also warned that governments could derail the recovery if they fail to take steps to right their finances and make their economies more business-friendly, such as by cutting excessive regulation on hiring and firing. Governments also need to push troubled banks to strengthen their finances.
"The ECB cannot supplant governments for the lack of structural reforms," he said, and "cannot clean bank's balance sheets."