ECB Likely to Cut Rates by 50bps

Since October, the European Central Bank has cut its benchmark interest rate by 2.5 percentage point and we expect a 50 bps reduction this week. But can rate cuts help to fight the ongoing deterioration on the European economy by boosting credit? We don’t think so.

At Trading Economics, we think that influence of lower interest rates on credit availability in Europe may be very limited as not lower demand for loans but the loan supply itself is the major source of the slowdown in lending growth. Indeed, banks are not likely to lend as they need to repair their overstretched balance-sheets. Moreover, if overnight rates reach zero, the ECB deposit facility and the overnight rate will offer the same rate. Under those circumstances, the interbank market may fade away even more with banks depositing excess funds at the ECB rather than in the money market. In addition, deposit rates at zero may squeeze bank profits and wear down an already scarce bank capital.

Looking ahead, there is another danger by the corner. In the case of the Euro Area, the monetary policy influence ends on zero interest rates. The ECB cannot use quantitative easing like United Kingdom or United States as it doesn’t have the common bonds and it would be very difficult to determine, which of its 16 governments' bonds it should buy.

Anna Fedec,
3/2/2009 7:49:26 PM