BLBG: ECB Cuts Key Rate to Record Low of 1%, May Lengthen Bank Loans
The European Central Bank cut its key interest rate to a record low of 1 percent today, and may offer banks longer-term loans to stem the region’s worst recession since World War II.
ECB officials meeting in Frankfurt lowered the benchmark rate by a quarter point, as predicted by all 53 economists in a Bloomberg News survey. Separately, the Bank of England left its key rate at 0.5 percent and increased its asset-purchase program. ECB President Jean-Claude Trichet, who has promised to unveil new policy measures to tackle the crisis, holds a press conference at 2:30 p.m.
“That’s it with rates,” said Stephane Deo, chief European economist at UBS AG in London. “They are now moving into unconventional territory. Trichet will announce an extension of the bank loan maturities and will have to flag that the ECB will keep all other options open.”
The difficulty for Trichet is that his 22-member Governing Council is split over how best to proceed. Germany’s Axel Weber wants the ECB to signal that 1 percent is the floor for the key rate and has argued against buying government or corporate debt to boost the economy. Others such as Athanasios Orphanides of Cyprus say asset purchases and deeper rate cuts may be needed.
‘Woefully Inadequate’
“The continuing divisions and bickering risk delaying the appropriate policy response,” said James Nixon, an economist at Societe Generale SA in London. “What they announce today will be woefully inadequate given the challenges facing the economy.”
Having cut their key rates to close to zero, the Bank of England, U.S. Federal Reserve and Bank of Japan are now buying bonds, effectively printing money to reflate their economies in a policy known as quantitative easing.
With recent economic reports in Europe suggesting the worst of the recession is over, Trichet may find common ground around the less aggressive approach put forward by Weber. The pace of decline in Europe’s service and manufacturing industries is easing and factory orders in Germany, the region’s largest economy, unexpectedly rose in March.
“The recent stronger data have increased the risk that the bank will settle for a more prudent approach,” said Marco Annunziata, chief economist at UniCredit Group in London. “This would be a mistake. The war against the financial and economic crisis is not won yet.”
Weber’s Prescription
Arguing that asset purchases are not required, Weber is pushing for the ECB to extend the maturities on its loans to banks to ease tensions in money markets.
The measure may force colleagues to sign up to his second request -- a signal from the ECB that interest rates won’t drop any further. That’s because banks would be reluctant to take up long-term loans if they thought credit could get cheaper.
Council member Yves Mersch and Executive Board members Juergen Stark and Lorenzo Bini Smaghi have signaled support for Weber’s view. They’re squaring off against Orphanides, Nout Wellink and George Provopoulos, who want to preserve the option of further action. That has opened perhaps the biggest split among ECB policy makers in the bank’s 10-year history.
The 16-nation economy will shrink 4.2 percent this year, according to the International Monetary Fund, more than the projected 2.8 percent contraction in the U.S. and 4.1 percent slump in the U.K.
Deflation Threat
While some economic reports are pointing to stabilization, lending to companies and consumers dropped for a second straight month in March and a European Commission survey shows households expect prices to fall over the next 12 months.
Inflation was 0.6 percent in April. The ECB, which aims to keep the rate just below 2 percent, says it may dip below zero this summer.
“If inflation threatens to remain significantly below 2 percent for a considerable period of time, then additional policy easing could be warranted” after May, Orphanides, a former Fed adviser, said in an April 14 interview.
Even though almost three quarters of company financing in the euro area comes from banks, buying corporate debt may be helpful because “all asset markets are interconnected,” Orphanides said.
“The euro area is clearly experiencing a deep recession,” said David Mackie, an economist at JPMorgan in London. “It is hard to see how the region can avoid something that looks a lot like deflation. The ECB should be putting in place the most accommodative policy stance possible, and leaving it in place for an extended period of time.”
