Eurozone interest rates slashed

Mid Devon Star: The European Central Bank has cut interest rates The European Central Bank has cut interest rates

Eurozone interest rates were slashed from 0.25% to 0.15% today as policy makers battle to revive the continent's moribund economy and stave off the threat of deflation.

The European Central Bank (ECB) also cut the overnight deposit rate for lenders that hold money with it from zero to -0.1% - effectively penalising them for hoarding cash and pushing them to lend.

It comes after inflation in the 18-nation bloc fell to 0.5% while growth in the first quarter was confirmed at a lacklustre 0.2% and survey data indicated further slowing.

In London, the Bank of England left interest rates on hold at 0.5% despite rumblings that some members of the Monetary Policy Committee were edging closer to voting for a hike.

The cut was widely expected. Howard Archer, chief UK and European economist at IHS Global Insight, said it was "thoroughly justified by the mounting risk of persistent very low eurozone inflation morphing into deflation".

The reduction by 0.1% "may be seen on the tentative side", he said.

He added: "Despite being widely anticipated and in some quarters criticised for occurring too late, it is still a bold and unusual move by the ECB to take its deposit rate into negative territory. "

But Schroders European economist Azad Zangana argued against the deposit rate cut.

"We expect banks to simply pass on the costs to households and businesses, either by charging fees for savers, but more likely through higher interest rates on new borrowers - the opposite of what the ECB is trying to achieve."

Carsten Brzeski of ING Bank said the ECB had "entered unchartered new territory in its quest to support the eurozone economy".

"Will it help to kick-start the economy? Probably not, but at least it demonstrates the ECB's determination and ability to act," he said.

Policy makers fear the possibility of the eurozone plunging into a damaging spiral of falling prices, with an unexpectedly sharp drop in inflation to 0.5% in May adding to the threat.

Low inflation makes it difficult for individuals and governments who have borrowed money to reduce debts. Deflation can stifle growth as consumers delay spending.

Meanwhile, eurozone unemployment remains stubbornly high at 11.7%.

Prospects in Europe, a key trading partner to Britain, are also crucial to domestic economic hopes, with the possibility of further crisis on the continent seen as a risk to the recovery in the UK.

The pound edged up against the single currency at 1.23 euros.

Former Bank of England official Andrew Sentance tweeted that it could reach 1.25 euros by the end of the month if minutes of the latest MPC meeting showed some votes for higher rates.

The nine-member committee has been unanimous on maintaining the status quo in recent months. The quantitative easing (QE) programme of asset purchases pumping money into the economy has also stayed on hold at £375 billion.

Signs of healthy growth in the UK have created pressure on the Bank of England to consider when rates should rise.

But the MPC is not yet ready for a hike despite the surge in house prices, with new data showing that they increased at their strongest month-on-month pace since 2002 in May.

Figures from Halifax showed they rose by 3.9% last month, or 8.7% year on year, while PMI data from the UK this week indicated strong continuing growth in the wider economy.

Officials must consider the impact of low borrowing costs on the future path of inflation, though the Bank has said it would rather utilise other tools to curb any property bubble before using rates - only to be deployed as a "last line of defence".

Martin Beck, senior economic adviser to the EY Item Club, said: "While today's decision by the MPC to leave interest rates on hold was predictable, the era of unanimity among MPC members may be coming to an end.

"Recent speeches and interviews suggest that opinions among the committee may be diverging on the case for maintaining interest rates at their current ultra-low level."

But he added: "Despite our expectation of continued strong economic growth and falling unemployment, a rate hike still looks unlikely until well into 2015.

"A split vote on the MPC may emerge sometime in the next few months, but the committee's hawks are set to remain in a minority for some time to come."

ECB president Mario Draghi said the ECB interest rates "will remain at present levels for an extended period of time in view of the current outlook for inflation".

He added: "Together, the measures will contribute to a return to inflation levels closer to 2%."

The ECB currently foresees inflation at 0.7% for this year, gradually rising to reach 1.5% by the last quarter of 2016.

Mr Draghi painted a gloomy picture of current economic conditions in Europe, with unemployment remaining high, lending to the private sector contracting, and tightening of government and companies' finances weighing on the pace of recovery.

He also set out an initial 400 billion euro (£323 billion) package of targeted financing along similar lines to the Bank of England's Funding for Lending scheme (FLS), to stimulate lending to households and businesses.

These targeted longer-term refinancing operations (TLTROs) will offer cheap finance to lenders in return to lending to the real economy.

But unlike the initial phase of FLS - which was launched in 2012 - the scheme may not be used to support house purchases. FLS has more recently been altered to focus purely on business lending.

Mr Draghi said the ECB had learned from other central banks - "especially the Bank of England" - but added that "the final result is fairly different from the Bank of England's".

Another measure announced today will see the ECB suspend weekly operations "sterilising" its purchases of government bonds from some of the eurozone's troubled economies.

This move has been described as QE, or money printing, by the back door. This is because the "sterilising" measures drain cash from financial markets so that the bond purchases do not amount to adding extra money to the system. Suspending this reverses the effect.

The ECB held back from embarking on full-blown QE - employed by the UK or the US - a policy which could prove politically fraught in the 18-member bloc.

But Mr Draghi sought to make clear that the central bank was "not finished" and could take further action, leaving the door open for such "unconventional" measures.

He said: "The broad-based asset purchases programme is certainly one of these unconventional instruments."

Comments (1)

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9:09pm Thu 5 Jun 14

loosehead says...

So the EU is telling us/advising us on how to run our economy whilst asking for £1.7billion more from us yet can't run the Eurozone or sort out it's problems?
So the EU is telling us/advising us on how to run our economy whilst asking for £1.7billion more from us yet can't run the Eurozone or sort out it's problems? loosehead
  • Score: -1
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