ECB Cuts Deposit Rate, Lifts Marginal Lending Rate
The European Central Bank cut the interest rate it pays banks to deposit money with it overnight and lifted its emergency lending rate in an effort to jolt financial companies into lending more to each other.
ECB President Jean-Claude Trichet and his governing council said after meeting in Frankfurt today that from Jan. 21 the deposit rate will be reduced to 100 basis points below its benchmark rate and the marginal lending rate will be increased to 100 basis points above it. Both are now separated from the ECB’s key rate of 2.5 percent by 50 basis points.
By lowering incentives to leave cash with it, the ECB is seeking to encourage banks to lend more as the euro region economy suffers the first recession in 15 years. Trichet and other officials have expressed concern that following the U.S. Federal Reserve in cutting the benchmark rate closer to zero won’t boost the economy as long as banks are hoarding cash.
“They have said they weren’t happy with banks not lending to the economy, so now they are discouraging them from putting the money in the central bank,” said Stefan Bielmeier, an economist at Deutsche Bank AG in Frankfurt.
The new rates will come into effect almost a week after the ECB council next convenes on Jan. 15 to set its benchmark rate which it has lowered 175 basis points since early October, the fastest reduction in its 10-year history. Investors are betting on another cut next month even as Trichet and other officials signal they may pause.
Continuing its attempt to thaw frozen money markets, the ECB also said today it will continue to provide unlimited liquidity at a fixed rate “for as long as needed, and at least until the last allotment of the third maintenance period in 2009 on March 31.”
Overnight Deposits
As banks have remained risk-averse since the Sept. 15 collapse of Lehman Brothers Holdings Inc., overnight deposits at the bank have surged. Deposits rose to 200.4 billion euros ($288.6 billion) yesterday, almost four times the daily average of 534 million euros in the year until Sept. 15. They reached a record 297 no faxing pay day loans.4 billion euros on Nov. 6.
The euro region already is in a recession and the ECB projects the economy will shrink about 0.5 percent next year, which would be the first full-year contraction since 1993. Business confidence in Germany, Europe’s largest economy, dropped to the lowest in more than a quarter century this month, the Munich-based Ifo institute said today.
Central banks around the world are cutting borrowing costs to contain the fallout from the financial crisis. While the ECB has also done so, Trichet said Dec. 15 that there is a limit to how far it can cut rates and suggested it may not do so in January.
Federal Reserve
The U.S. Federal Reserve reduced its key rate on Dec. 16 to between zero and 0.25 percent, down from 1 percent.
The lower deposit rate may not dissuade banks from storing cash at the ECB, said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc. Banks may have been depositing money with the central bank “because of counterparty risk considerations rather than to seek a return on these deposits,” he said.
Even if banks stop turning to the ECB they are unlikely to lend elsewhere, said Laurent Bilke, an economist at Nomunra International. “It will not really increase credit to the economy,” he said.
If banks don’t begin lending more, the ECB may start to guarantee short-term interbank loans by creating a clearinghouse, Cailloux said. ECB Vice President Lucas Papademos said on Dec. 15 that is “a concept worth studying.”
The ECB also said today it will maintain its current voting system in which every member of the council has a voice in setting rates. According to the Maastricht Treaty which established the central bank, a rotation system in which council members take turns to vote should be implemented when the euro- area membership reached 16. Slovakia becomes the 16th member on Jan. 1.