News | Wednesday, 03 June 2009

Euro zone interest rates likely to remain unchanged at all-time low of 1 per cent

Charlot Zahra

After three successive rate cuts leading to an all-time low of 1 per cent since March, the European Central Bank (ECB) is finally expected not to cut its base rate tomorrow.
A month ago, the ECB’s Governing Council had lowered its key policy interest rate by another 0.25 basis points to a new low of 1.00 per cent at the Governing Council’s May meeting.
Since the beginning of 2009, there had been four interest rate cuts, with a total decrease of 1.5 per cent in the bank’s key policy rate within the space of five months.
In fact, according to a note sent out last Friday by international credit rating Moody’s, the ECB “will keep its key policy interest rates on hold at 1 per cent”.
In June, the ECB was likely “to revise down its previous growth forecasts and provide further details of its asset purchase programme,” Moody’s added in its note.
ECB President Jean-Claude Trichet had indicated that the current monetary stance “takes into account the bank’s bleaker outlook”, the international credit rating agency said.
ECB Governing Council member, Vitor Constancio said on Thursday there was no decision at the bank’s last rate-setting meeting on whether interest rates could be cut below 1 per cent tomorrow.
“I will repeat what (ECB President) Trichet said last time, that there was no decision on that whatsoever,” Constancio told reporters, when asked if interest rates at one per cent was the lowest they would go.
Even though the euro area was struggling with the worst recession since the creation of the single currency, the ECB had repeatedly ruled out cutting rates to zero.
A number of top ECB policymakers had said they were equally reluctant to take them below 1 per cent as it would risk paralyzing money markets and send the wrong signal.
At 1.00 per cent, the ECB’s main rate remained higher than those of other major Central Banks globally. The US Federal Reserve’s target policy rate was between zero and 0.25 per cent, the Bank of Japan’s interest rate stood at 0.1 per cent and the Bank of England’s at 0.5 per cent.
However ECB members pointed out that the bank’s tactic of flooding money markets with extra funding have helped push all-important inter-bank rates down to levels parallel with elsewhere.
A poll of 79 economists published on 30 April by Reuters showed that 18 respondents expected euro zone interest rates to fall below 1 per cent by the end of this year, despite some ECB indicating reluctance to cut below that level.
According to foreign and local analysts, the ECB was slowly moving towards non-standard policy measures, as already hinted by Trichet himself time and time again.
So far, the ECB had pushed unlimited amounts of shorter-term funds in its regular refinancing tenders but these tactics cannot solve investors’ wariness of bank bonds and the consequent shortage of long-term bank lending.
ECB Governing Council member Mario Draghi said on Friday there were no definitive signs yet that the global financial crisis was coming to an end, although the risk of protracted deflation now appeared slight.
“There are encouraging signs. The likelihood of deflation, in the sense of a protracted decline in the general price level, now appears slight,” he told the Bank of Italy’s assembly.
However, Draghi warned that “it is not yet possible to point with certainty to a definitive cyclical inversion.”
The Italian member of the ECB Governing Council said there would be upwards pressure on world interest rates in the next two years from the need to place “massive volumes” of government securities on the market, which would “check” economic recovery.
Draghi recommended that banks “limit the distribution of profits” to shareholders and said the revision of supervision in Europe “needs to be strengthened” in some points.
However, there were some initial signs that the tough recession that had hit the Euro area was easing slightly.
Markit’s Eurozone Flash Services Purchasing Managers Index (PMI), a measure of service and manufacturing activity, rose to 44.7 in May from 43.8 last month, beating the consensus estimate.
May was the third month in a row that the index picked up and took it to its highest level since October last year.
In France, the PMI index showed the economy performing more strongly than the euro zone as a whole. Markit said a recovery in France could be earlier than current forecasts of a rebound in the fourth quarter.
The rate of decline in the private sector in Germany, Europe’s largest economy, was its slowest in seven months.
Predictions by some economists of a return to growth as early as the last quarter of this year were, however, tempered with concerns that data may yet obscure more complex underlying weaknesses in the economy.
“It is grounds for hope that things will improve over the next few months,” Peter Dixon, an economist at Commerzbank, told Reuters. “I’m not getting carried away.”



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03 June 2009

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