European Central Bank President Mario Draghi opened a new front in the battle against the debt crisis after cutting the benchmark interest rate to a record low today.
Speaking in Bratislava, Draghi signalled that officials may take the unprecedented step of charging banks to park excess cash with the ECB overnight and that another reduction in the main rate is possible.
“We will look at all the incoming data and stand ready to act if needed,” Draghi said at a press conference in the Slovakian capital after the ECB cut its key rate by a quarter point to 0.5 percent. Asked if further action could include taking the deposit rate negative from its current level of zero, he said: “We will look at this with an open mind.”
The euro fell on the prospect of a negative deposit rate, which would see the ECB venturing into territory few others have dared to tread. With the 17-nation economy mired in recession and risks to the outlook “on the downside,” Draghi is ramping up his response.
“At last, the fastest contracting region in the world no longer has the highest central bank policy rate of all major developed economies,” said Chris Williamson, chief economist at Markit in London.
Draghi said the ECB will continue to lend banks as much money as they need at least through mid-2014, extending the policy by more than a year. Previously, the ECB announced six-month extensions. It has also started to consult with European institutions on ways to improve the flow of credit to companies using collateralized loans.
“All the options are still very open here, our thinking is very much in a preliminary stage given the complexity of the issue,” Draghi said. Still, “to ensure adequate transmission of monetary policy, it is essential that the fragmentation of euro-area credit markets continue to decline further.”
The euro dropped after his remarks, falling to $1.3047 at 5:25 p.m. in Frankfurt from $1.3192 at the start of Draghi’s press conference.
While the ECB maintained its assessment that risks to the price outlook are broadly balanced, inflation slowed to 1.2 percent in April, well below the central bank’s 2 percent limit.
Since Draghi pledged last month to act if the economic outlooked worsened, manufacturing output contracted at a faster pace and unemployment rose to a record high of 12.1 percent.
“The ECB finally started to respond to the recession-bound economy and low inflation,” said Nick Kounis, head of macro research at ABN Amro in Amsterdam. Draghi’s comments suggest the ECB “has a clear easing bias and, given the risk that inflation gets stuck at uncomfortably low levels, we think that the chances of further monetary easing over the next few months are significant,” he said.
Holger Schmieding, chief economist at Berenberg Bank in London, said the ECB will only lower rates again if the economy gets worse, something he doesn’t anticipate.
“With the worst of austerity behind most peripheral countries and the global economy likely to regain some momentum over the summer, leading indicators in the euro zone will probably stabilize and start to turn up within two to three months,” he said.
A negative deposit rate may discourage banks from parking excess liquidity with the ECB overnight, potentially prompting them to lend the cash instead. On the other hand, it could hurt banks’ profitability by lowering money-market rates, possibly hampering credit supply to companies and households and reducing banks’ incentive to lend to other financial institutions.
Denmark is currently the only country in Europe with a negative deposit rate.
Draghi said while there are “unintended consequences” from using this tool, the ECB is “technically ready” and would “address these consequences if we decide to act.”
The ECB narrowed the so-called rate corridor around its benchmark today by leaving the deposit rate at zero and reducing the marginal lending rate to 1 percent from 1.5 percent.
Taking the benchmark any lower would invite a cut in the deposit rate in order to maintain that corridor. Draghi indicated that some officials wanted to reduce the main rate by 50 basis points today.
“He not only kept the door for a further refi cut open and implied that some members had argued for a 50 basis-point cut, he also revealed an open mind about a deposit rate cut,” said Christoph Rieger, head of fixed-rate strategy and Commerzbank AG in Frankfurt. “Irrespective of whether this cut materializes or not, this statement should keep rate speculation more underpinned.”