European Central Bank seen cutting key interest rate

Frankfurt: The European Central Bank (ECB) will cut its key interest rate, already at an all-time low, at its policy meeting next week and may also unveil new measures to kick-start bank lending to businesses, analysts predict.

The ECB’s rate-setting governing council is to convene in Bratislava on Thursday, in the first of two meetings held each year outside the bank’s headquarters in Frankfurt.

And while ECB officials and watchers agree that a quarter-point reduction in the bank’s “refi” refinancing rate - held at an historic low of 0.75 per cent since July 2012 — will not actually provide much of a fillip to the Eurozone’s flailing economy, analysts say the central bank has few other weapons at its disposal for the time being.

“On balance, we think that an interest rate cut is marginally more likely than not, but it will make little difference to the bleak economic outlook,” said Capital Economics economist Jennifer McKeown.

At the council’s last meeting on April 4 there had been “extensive” discussion of a possible rate cut, ECB chief Mario Draghi told reporters afterwards.

But he insisted the central bank was “ready to act” if needed.

Since then, a raft of economic data has shown that the economies of 17 countries that share the euro are still very fragile.

Even the region’s top economy Germany, which has consistently outperformed its partners and neighbours, is beginning to feel the squeeze.

“The economic indicators published in recent weeks have proved so disappointing that the ECB’s assessment of an economic recovery in the second half now seems doubtful,” said Commerzbank economist Michael Schubert.

“Since a number of council members have hinted at a possible rate cut in the event of this happening, we now expect the bank to cut the refi rate to 0.5 per cent at its next meeting,” he said.

Royal Bank of Scotland economist Richard Barwell said the ECB “has reached the point where it has to do something.”

ECB board member Joerg Asmussen cautioned last week that additional monetary easing may not actually prove very effective.

“Due to impaired monetary policy transmission, the pass-through of rate cuts to the periphery would be limited, and this is where they are most needed,” he said.

Thus, any move on rates would be a “largely symbolic gesture,” said Barwell at RBS.

As such, the ECB would more likely want to move sooner rather than later, Barwell said.

UniCredit economist Marco Valli was not so sure.

“The exact timing of the rate cut is a close call, but our guess right now is that June is more likely than May, also because by then the ECB will have first-quarter growth numbers at hand” and will have finished compiling its own latest staff projections, he argued.

The ECB’s main headache at the moment is the weak level of lending activity in the single currency area, with the availability of loans to small and medium-sized enterprises (SMEs) - which form the backbone of the Eurozone economy — continuing to deteriorate.

New data on Friday suggested the phenomenon was not only due to weak demand, as the ECB has repeatedly argued, but also because SMEs are finding it difficult to obtain financing.

UBS economist Reinhard Cluse said any moves to get credit flowing again to the SMEs would take time, because they would likely require the European Investment Bank becoming involved.

And that would need the agreement of the EU and national governments.

“A top-level agreement could probably be reached relatively quickly. However, the problem with such a loan guarantee scheme is that it would take quite a bit of time to roll it out at the micro-level and that it is therefore unlikely to achieve quick results,” Cluse argued.

Berenberg Bank economists Holger Schmieding and Christian Schulz said the channel of bank loans to businesses has become clogged by the need for banks to repair their balance sheets.

So the ECB “could relax rules for its liquidity operations to allow more loans to SMEs as collateral, thus boosting their attractiveness for banks.”

In addition, the ECB might provide some additional guidance on how long the current generous liquidity provision policy will remain in place, beyond the current “for as long as necessary,” they suggested.

Commerzbank economist Schubert nevertheless pointed out that whichever measures the ECB unveiled, “the main underlying problem is that it would be gaining time, not tackling the causes of the problems,” which only governments could do.

“In other words, the (ECB) can do very little,” Schubert concluded.