November 8, 2013 in Business

European bank cuts key interest rate


FRANKFURT, Germany – The European Central Bank sent a message Thursday with a surprise cut in its benchmark interest rate: It’s prepared to do more to fortify the euro alliance’s economy.

The question is: Will anything the ECB does be enough?

Thursday’s quarter-point cut, to a record low of 0.25 percent, will go only so far. Economists say Europe’s fundamental problems – shaky banks, slow growth and heavily indebted governments – need more support. And not just from the central bank.

“While the ECB’s largely unexpected decision to cut interest rates was welcome, the central bank cannot address the deep-seated problems still facing the currency union,” said Jonathan Loynes, chief European economist at Capital Economics. “A small cut in interest rates is not going to transform the economy.”

Governments need to reduce unemployment, which is at a record 12.2 percent across the eurozone and not forecast to drop for years. They also need to reform their economies to improve growth and reduce debt. Leaders, meanwhile, need to finish setting up an EU-wide oversight system for the banks and create an agency that can take on the costs of saving troubled lenders.

To help fix the banks, the ECB will need to complete a yearlong review of their balance sheets to reveal hidden weaknesses and strengthen their finances.

With its rate cut, the ECB did what it could to show it is ready to support the economy now.

On Thursday, ECB President Mario Draghi and the bank’s governing council were responding in particular to an alarming drop in inflation, to just 0.7 percent in October. The rate is far below the ECB’s inflation target of 2 percent and a sign of weak demand in the economy.

Low inflation is not itself a disaster. But it’s a nightmare if it turns into outright deflation, an economic death spiral in which a chronic, broad-based fall in prices keeps people from spending as goods get ever cheaper. That’s what happened in Japan, causing years of economic stagnation.

The rate cut highlights the diverging fortunes of the economies of Europe and the U.S., where the recovery has been stronger and the Federal Reserve is preparing to tighten its monetary policy.

The immediate benefit of Thursday’s cut was evident in a drop in the euro. Startled currency traders sent its exchange rate down 2 1/2 cents against the dollar after the decision, to around $1.33.

The bank’s willingness to move without waiting to tip markets ahead of time could enhance its credibility as the eurozone institution most able to act decisively, some economists said.

Associated Press

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