How the ECB is trying to revive the eurozone

Mario Draghi

What has the European Central Bank done?

Mario Draghi, the ECB president, has announced four key measures:

  • A cut in the main interest rate used across the eurozone from 0.05% to zero.
  • A cut in the deposit rate from -0.3% to -0.4%.
  • Increasing the amount of bonds the ECB is buying, under a process called quantitative easing, by €20bn to €80bn. Crucially, this will now include bonds issued by companies and not just by governments.
  • New ultra-cheap four-year loans to banks, allowing them to borrow from the ECB at negative interest rates.

Why is this a significant move?

The ECB wants to get money into the financial system by discouraging banks from holding on to deposits and instead lend out money as cheaply as possible to businesses and households.

The 19 countries in the eurozone have had a negative interest rate for deposits since June 2014. But this is the first time the ECB has set the rate at which it lends to banks to zero.

Since June 2014, the ECB has been trying to discourage banks from holding on to savings by cutting the deposit rate to -0.1%. Since then it has cut it to -0.2%, then to -0.3% last December and the rate has now been cut to -o.4%.

By increasing the amount of quantitative easing and the type of bonds it is prepared to buy up, the ECB is also signalling it wants to get more money pumped around the eurozone financial system.

Why is this happening?

The ECB is keen to stimulate the eurozone, against the backdrop of an imperilled global economy. Data in February showed Greece fell back into recession and Italy slowed to near stagnation. Germany, the eurozone’s largest economy, grew by just 0.3%. On top of weak growth, inflation is negative – which can discourage businesses and consumers from spending. Headline inflation dropped to -0.2% in February, down from 0.3% in January. Today, Draghi has said he expects growth of just 1.4% across the eurozone this year, down from 1.7% three months ago.

Do other countries have negative rates?

Sweden’s central bank became the first to lend at a negative rate when in February 2015 it announced a negative repo rate – its main lending rate to commercial banks. Other countries that have negative rates for deposits include Japan, Switzerland and Denmark.

Will it work?

Ultra-low interest rates create difficulties for commercial banks because it makes it harder for financial institutions to lend profitably. The ECB, though, is trying to mitigate the impact by allowing the rate at which banks borrow over the long term to drop into negative territory, too.

Analysts at the consultancy Capital Economics said: “There is no guarantee that its latest ‘bazooka’ will be any more effective than previous ones in securing the strong and sustained growth required to eliminate the threat of deflation in the currency union and allow the peripheral countries to tackle their debt problems. The ECB has belatedly delivered, but it can’t work miracles.”

And Michael Martins, an economist at the business lobby group the Institute of Directors, said the move could prove counterproductive. “Monetary policy is not enough to wake Europe from its slumber. The ECB has felt compelled to act because of the stubborn deflation stalking the continent, but without individual governments stepping up to the plate and implementing more structural reforms, the impact of a further loosening in monetary policy will be limited.”

Powered by Guardian.co.ukThis article was written by Jill Treanor, for theguardian.com on Thursday 10th March 2016 14.41 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010

 

JefferiesAnd the Best Place to Work in the global financial markets 2016 is...

Register for Financial Markets News Alerts