European Central Bank Cuts Rates to New Low to Help Economy

European Central BankBy DAVID McHUGH

FRANKFURT, Germany -- The European Central Bank has cut its key interest rate by a quarter percentage point to a record low of 0.75% to boost a eurozone economy weighed down by the continent's crisis over too much government debt.

The move followed a rate cut by China's central bank and new stimulus measures by the Bank of England as global financial authorities seek to shore up a slowing global economy.

Stock markets rose briefly on the news, mainly because China's rate cut was unexpected. But the gains did not last long as investors seemed worried about the extent of the slowdown in the global economy. Germany's DAX was up 0.4% while the Dow futures were flat.

European leaders last week agreed on new steps to strengthen market confidence in their shared euro currency bloc. They agreed to set up a single banking supervisor to keep bank bailouts from bankrupting countries and made it easier for troubled countries to get bailout help.

Those steps helped calm financial markets this week, which have expected the ECB to follow up with more help in the form of a rate cut.

The cut in the refinancing rate could mean lower borrowing costs for banks, businesses and consumers. The rate is what banks pay the ECB for loans and through them influences many other rates in the economy. In theory cheap borrowing makes it easier for businesses and people to decide to spend, but some economists say it may have little effect since interest rates are already very low.

The ECB also cut its overnight deposit rate -- what it charges banks for depositing their money with the ECB overnight -- to zero. Cutting the rate to zero eliminates already paltry returns and increases the incentive for banks to lend that money to each other or to businesses rather than park it with the ECB.

However, cutting the rate to zero does not eliminate the reason banks are often reluctant to lend to each other: fear that other banks may become insolvent and not pay the money back.

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

Lending activity 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% 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% in the first quarter.


In the U.S., weak economic indicators have raised speculation that the 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% 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 2½ 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 their budget deficits. Spain has asked for as much as 100 billion euros 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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9 Comments

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PBanks

Even with the Banks lowering the Interest rates temporarily, they know they will have to raise them back up, to where they should be to get the edge on Inflation. Unlike in this country the fed and the banks are holding everything down. With the junk money investments and bond sales. Even China with their economy slowing down. They will start to sell off their bonds, to keep their country out of trouble. It's temporary. We are due for another Wall Street Bust with the scams the traders have done for the last 2 years. Even they need to clean up the market books. The junk money that is.

July 19 2012 at 9:56 PM Report abuse rate up rate down Reply
goldaxe

What........The austerity plan did not stimulate their economies?

July 07 2012 at 2:41 AM Report abuse rate up rate down Reply
zpike

And, for those of you that want higher interest rates in the US that is how you will get them
Before the banks close their position they will get short the USD and then flood the Treasury market when they sell their Treasuries to close their positions, driving yields on US Treasuries through the roof.

pretty neat gig wouldn't you think?

July 05 2012 at 2:36 PM Report abuse rate up rate down Reply
zpike

For those of you out there that haven't figured it out this move will do nothing to increase lending to the private sector. It will further hasten the collapse of the Euro and position the banks to profit from it. Essentially what we have is government intervention to assure a self-fulfilling prophecy
example;
Bank borrows Euros and purchases US Treasury obligations (1,25 : 1.00)
at this point a riskless transaction that yields 3/4% so its okay to hold for a while
but
If the Euro collapses or just moves to parity with the USD (1:1)
The European bank closes their position and makes 25% on borrowed money with a holding cost of +3/4%

Sow, set up like this, how do you think this situation will turn out?

July 05 2012 at 2:29 PM Report abuse rate up rate down Reply
Randy

The banks need to raise interest rates. Just to pay for the mistakes they made in the past. The low interest rates are going to suck more first time home owners into the housing market. They want new debt.

July 05 2012 at 1:57 PM Report abuse -1 rate up rate down Reply
Debbie

They can cut the rates as low as they want to. It's not going to change thing until people are working and spending money.

July 05 2012 at 12:39 PM Report abuse -1 rate up rate down Reply
talari

It seems like every week they have a new brainstorm to save the world's doomed economies.

July 05 2012 at 12:29 PM Report abuse +1 rate up rate down Reply
nladney

This all sounds like a big game of musical chairs. Each time the music stops another country goes down the tubes.

July 05 2012 at 11:26 AM Report abuse +1 rate up rate down Reply
dray907023

REARRANING THE DECK CHAIRS ON THE TITANIC . THERE IS NO WAY TO KEEP THE REAL ESTATE FROM TANKING . THEY ARE ONLY STALLING THE INEVITABLE WHILE THEY EAT THE SEED CORN

July 05 2012 at 10:22 AM Report abuse +1 rate up rate down Reply