The European Central Bank may cut interest rates on Thursday as the 17-nation economy has shown increasing weakness in recent weeks. However, economists think a reduction in rates without accompanying efforts to boost bank lending is unlikely to make much difference at this juncture.
The Governing Council led by ECB President Mario Draghi is set to meet in the Slovak capital of Bratislava, where it is expected to announce a reduction in the main refinancing rate, or the refi, by a quarter-basis point to 0.5 percent. The bank has held the rate steady at 0.75 percent for nine consecutive months.
Meanwhile, the bank is expected to leave the deposit rate that is already at zero, untouched. The marginal lending facility rate is also likely to be left unchanged at 1.50 percent.
The previous change in euro area interest rates was a quarter-point reduction in July 2012.
The latest run of weak economic data has strengthened expectations for a reduction in rates this month. Data from a survey by the European Commission showed on Monday that Eurozone economic confidence declined more than expected in April and Eurostat reported that the unemployment rate for the single currency region climbed to a new record of 12.1 percent in March.
Boosting rate cut hopes further, the statistical agency reported yesterday that headline inflation slowed to a three-year low of 1.2 percent in April, well below the ECB's target of "below, but close to 2 percent". Core inflation that excludes energy, food, alcohol and tobacco, slowed to 1 percent from 1.5 percent in March.
"Given all of this bad news, it will be a big disappointment if the ECB does not both cut interest rates this week and announce more unconventional policies to boost bank lending," Capital Economics Senior European Economist Jennifer McKeown said yesterday.
"But neither is likely to prevent a sharp contraction in the euro-zone economy this year."
Recent ECB rhetoric also have hinted at policy easing in the near term, but revealed some dissenting views at the same time. Last week, ECB Vice-President Vitor Constancio said the bank "stands ready to act" if economic conditions in euro area continue to worsen.
"Monetary policy is accommodative and, as we have said, it will continue to be accommodative to respond to the present conditions, in which inflation is going down in a significant way," he said.
On the other hand, ECB Executive Board Member Joerg Asmussen has said the pass-through of rate cuts to the periphery would be limited due to impaired monetary policy transmission.
Interest rate reductions would further relax already unprecedentedly easy financing conditions in core economies, he said, while warning that lower interest rates for a longer period can eventually lead to distortions.
Fellow Executive Board member Benoit Coeure also expressed concerns over the situation, last week, and urged institutions to address the discrepancies in borrowing costs to businesses and take steps to ease credit constraints to small firms.
In the quarterly Bank Lending Survey published in April, the ECB said that the banks maintained tight credit standards on loans to both enterprises and households while the demand for loans has also declined.
"A rate cut without additional efforts to repair the transmission mechanism would quickly go up in smoke and could even be regarded as an act of despair," ING Bank Senior Economist Carsten Brzeski said this week.
"It is hard to believe that the ECB would first cut rates and come up with a broader SME funding scheme later."
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