European Central Bank (ECB) lowered Thursday the key interest rate by 0.25 percentage points, from 1% to 0.75%, and reduced the deposit rate to zero, unprecedented decisions in the history of the institution that tries to stimulate the European economy in the context of state debt crisis. Previously, the rate on deposits was 0.25%. ECB interest rate was 1% in the period May 2009 – April 2011, when it was reduced and then maintained at this level to boost lending to the economy during the global financial crisis.
Last year, the key interest rate was raised twice, in April to 1.25% and in July to 1.5%. After Mario Draghi took office as president, the ECB cut interest rates twice, to 1.25% in November and 1% in December. Most analysts have anticipated today’s move of the ECB, which marks a new precedent for the institution at a time of financial crisis and prolonged economic stagnation in the euro area. Overnight deposits at ECB became the preferred way of European banks to shelter money in times of extreme volatility in financial markets. Lowering deposit rates could encourage credit institutions to take the money elsewhere, on the state debt market or in the real economy.
China’s Central Bank on Thursday lowered the key interest rate by 0.31 percentage points to 6%, and the deposit rate by 0.25 points, to 3%, according to the Financial Times. Bank of England kept the monetary policy rate at 0.5%, where it is since March 2009, and injected another 50 billion pounds in the program to stimulate the economy with lowering interest rates in the bond market through purchases on the secondary market. Bond purchase program volume thus reached 375 billion pounds.
Euro area trading partners, such as UK, the United States and China are concerned about the impact of state debt crisis in the euro area economy, from both a commercial and financial point of view. U.S. Federal Reserve has recently expanded the program to change their bond portfolio in securities with extended maturity in order to lower interest rates and encourage lending.
“It’s a bold move, which will bring ECB on blazed roads. With unemployment rising and few signs of economic recovery, strong monetary remedies are needed. But to be honest, a reduction in interest rates will not by itself end the recession , it takes a lot more for this”, commented for Bloomberg Julian Callow, chief European economist at Barclays Capital. The economy of euro zone stagnated in the first quarter of this year, barely avoiding the recession, after a contraction of 0.3% in the fourth quarter of last year. Two consecutive quarters of GDP falling is technically recession.
State debt crisis forced already five euro countries to request external funding, namely Greece, Portugal, Ireland, Spain and Cyprus, and tensions in the euro area put to the test the global growth, to the dismay of trading partners on the continent, the Americas and Asia.
ECB interest rate cut is likely to stimulate significantly the reduced domestic demand on the continent, but will push down borrowing costs of banks in difficulty and could help to increase confidence in the markets caused by the decisions of the EU summit last week, which plans for strengthening anti-crisis projects and the first steps towards a deeper economic and financial integration in the euro area.
EU leaders decided at a summit last week to pave the way for direct recapitalization of distressed banks using the euro zone crisis funds, after the European Commission will have established a unique institution of banking supervision. The EU has also dropped, to investors’ satisfaction, the preferential status of the loan to Spain, for bank recapitalization, which would have had priority in repayment. Stock markets and the euro rose after the decisions in Brussels and borrowing costs of Spain and Italy have decreased substantially from levels of alert in the past few months.
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