The Joplin Globe, Joplin, MO

Business

July 5, 2012

ECB cuts key rate to new low to help economy

FRANKFURT, Germany — The European Central Bank cut its key interest rate by a quarter percentage point Thursday to a record low 0.75 percent to try to help ease Europe’s financial crisis and boost its flagging economy. The action, which was widely expected, is meant to make it cheaper for businesses and consumers to take loans.

In a more surprising move, the ECB also cut to zero the interest rate it pays banks on overnight deposits by a quarter percentage point. This pushes banks to lend the money, rather than sock it away with the ECB.

Stock markets initially rose after the news, but the gains quickly faded. Germany’s DAX stock index was up 0.4 percent while the Dow futures index was flat. The euro was down 1.1 percent at $1.2380.

Economists say the interest rate cuts might have only limited impact because rates were already low and banks remain wary of lending to each other, while businesses often see no reason to borrow in a slack economy.

“Today’s ECB interest rate cut does little to alter the bleak economic outlook,” said Jennifer McKeown, analyst at Capital Economics.

In an effort to ease the continent’s financial crisis, European leaders last week agreed to make it easier for troubled countries and banks to receive rescue loans and they signaled a greater willingness to use emergency funds to purchase government bonds. They also agreed to create a single Europe-wide banking regulator.

Collectively, the moves sent a message to financial markets that leaders from the 17 countries that use the euro could work together to fix their problems. They also helped lower the high borrowing costs for financially stressed countries such as Italy and Spain, the euro region’s third- and fourth-largest economies.

Lending activity in the eurozone has remained weak because businesses are not asking for credit because of the slow economy and out of fear that the eurozone may suffer a further financial calamity. Concerns remain that bankrupt Greece could eventually leave the euro, causing more turmoil, or that Spain and Italy could need bailouts that would strain the resources of donor countries.

The ECB move was accompanied earlier in the day by monetary stimulus in China and the U.K.

The Bank of England decided to purchase another 50 billion pounds in government bonds from banks, increase the money supply in the UK economy. The hope is the banks will use the extra cash to lend to businesses and households.

China’s central bank, meanwhile, cut interest rates for the second time in a month to shore up its economy, the second-largest in the world. Interest on a one-year loan was reduced by 0.31 percentage points to 6 percent effective Friday. Chinese authorities have rolled out a series of stimulus measures since March after economic growth slowed to a nearly three-year low of 8.1 percent in the first quarter.

In the U.S., weak economic indicators have raised speculation that the U.S. Federal Reserve may also have to do more to keep the U.S. economy growing. Some think the Fed might carry out a third round of bond purchases aimed at increasing the supply of money in the economy — so-called quantitative easing.

The Fed took more limited action at its meeting ending June 17, extending its so-called Operation Twist effort in which it sells short-term bonds and buys longer-dated issues to push down long term interest rates. The Fed meets next Aug. 1.

The economy in the 17 countries that use the euro is expected to shrink by a relatively mild 0.3 percent according to EU predictions. But recent data indicate the downturn could be worse. Business sentiment is dropping even in Germany, Europe’s biggest and strongest economy.

A bigger drop in eurozone output would make it harder for indebted countries to pay off maturing debt and convince bond investors to keep lending them money. Debts get larger compared to the size of the economy as output shrinks, while growth reduces the relative size of debt and increases tax revenues governments can use to meet their obligation.

The 2  1/2 year old eurozone crisis has seen Greece, Ireland and Portugal need bailouts from the other eurozone countries and the International Monetary Fund to keep paying their debts and covering ther budget deficits. Spain has asked for as much as (euro) 100 billion in rescue loans for its banks.

Markets rebounded after last week’s summit where European leaders took several steps to strengthen the shared euro currency and solve their crisis over too much government debt in some countries.

They made it easier for indebted countries to get bailout loans and eased the way for Europe’s bailout fund to buy their bonds in the open market, which is one way of lowering borrowing costs. They also agreed to work on creating a common banking regulator that would take the financial risk of bank bailouts off governments.

 

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