Europe's banks brace for interest rate cuts, with Mario Draghi expected to act

European Union

Europe's banks were bracing themselves over the weekend for much anticipated cuts in the eurozone's commercial interest rates to boost the currency zone's struggling economy.

European Central Bank (ECB) boss Mario Draghi is expected to reduce the rate at which commercial banks borrow from 0.25% to 0.15% to encourage business lending.

The Frankfurt-based institution is also expected to cut the interest rate it pays to banks that keep funds on deposit in a further move to discourage lenders from hoarding cash.

Draghi is under pressure to kickstart bank lending after recent figures showed that Netherlands, Italy, Finland and Portugal saw their economies contract in the first three months of the year while France stagnated. Only Germany prevented the eurozone from heading back into recession after after a 0.8% growth spurt.

Low inflation across the 18 members of the currency zone has also discouraged shoppers from spending on the high street and undermined business investment and union-led attempts to raise wages.

In April inflation rose to 0.7 from 0.5% in March, but remained in what the ECB calls the "danger zone" of below 1%, and well below the ECB's target of close to 2%.

Worse still, figures for May showed that Italy's EU-harmonised inflation rate eased to a weaker-than-expected 0.4% year-on-year from 0.5% in April. Corresponding inflation in Spain was 0.2%, down from 0.3%.

But the ECB is unlikely to mimic the US Federal Reserve and Bank of England and pump billions of euros into the banking system with a programme of quantitative easing (QE).

The ECB, which will announce its decision on Thursday, is known to have come close to voting for QE, but conservative forces on the governing council have resisted the plans.

"We are aware of the risks of a too prolonged low inflation period," Draghi told an ECB conference outside Lisbon last week, adding that he and his colleagues had to be "particularly watchful" for any negative price spiral.

At the last policy meeting in May, Draghi said the ECB was comfortable with acting in June if updated staff forecasts showed the situation remained the same or worse.

"Draghi's May press conference raised market expectations of action, and the ECB will want to appear bold," said Nikolaus Keis, economist at Unicredit. "The risk is that monetary conditions may quickly start tightening anew if the ECB's moves are perceived as too timid."

Howard Archer, chief European economist at HS Global Insight, said economic conditions in the eurozone "certainly justify strong action".

In the absence of further monetary support, the euro would rise against the dollar, hurting exporters and deterring business investment, he said.

"Ever since Mr. Draghi's comments after the 8 May ECB policy meeting that the ECB is "comfortable" with taking action in June to counter prolonged very low eurozone inflation and the strength of the euro, it has looked much more likely than not that the bank will follow through and move at its 5 June policy meeting.

He added: "However, we remain doubtful that the ECB will undertake full blown QE. We suspect this will only happen if eurozone consumer price inflation falls to new lows below 0.5% over the coming months and eurozone growth falters further."

Powered by article was written by Phillip Inman, economics correspondent, for The Guardian on Sunday 1st June 2014 19.04 Europe/London © Guardian News and Media Limited 2010


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