5th June 2014
The European Central Bank (ECB) has cut interest rates in a bid to stop persistently low Eurozone inflation turning into deflation.
It has slashed its key refinancing interest rate from 0.25% to 0.15% and moved its deposit rate into negative territory from 0% to -0.10%.
While the latter reduction means that cash deposits are now punitive the ECB is hoping the move will spur on banks to lend more.
ECB president Mario Draghi stated after the May policy meeting that the Governing Council is “comfortable” with taking action in June to counter prolonged very low Eurozone inflation and the strength of the euro.
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Within the region consumer price inflation fell to just 0.5% in May, well under the bank’s 2% target and the fact that the embattled Eurozone only managed 0.2% economic growth in the first three months of the year and continued falling bank lending to businesses reinforced the case for ECB action.
Howard Archer chief UK & European economist at IHS Global Insight said the decision is thoroughly justified. He added: “In fact, a cut of only 10 basis points may be seen as on the tentative side, although the ECB likely want to tread very carefully on the negative deposit rate front. It also may see a cut of only 10 basis points as keeping the door open to another small cut if Eurozone consumer price inflation heads lower or even fails to pick up.”
“Despite being widely anticipated and in some quarters criticized for occurring too late, it is still a bold and unusual move by the ECB to take its deposit rate into negative territory.”
Jennifer McKeown senior European economist at Capital Economics said the cuts were the bare minimum that the ECB could have offered after strong hints of impending action last month.
She added: “The reduction in the deposit rate below zero might have an “announcement effect” on the euro. But the positive effect of a small depreciation could easily be outweighed by the potential damage to banks’ profitability. Meanwhile, there is a risk that banks do not take up any offer of ECB funds and, even if they do, they might struggle to find firms that are keen to borrow.”
Steven Bell, chief economist at F&C Investments said: “Having pushed as hard as they can, the ECB must now sit back and wait to see if the economy responds. So far, the weaker euro is encouraging but only time will tell if there is broader economic response.”
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