On Thursday, the European Central Bank (ECB) announced the latest raft of measures which it hopes will provide an impetus for a stronger recovery within the Eurozone. The headline measure was the decision to slash the interest rate from 0.15% (where it has been since June) by 0.1% to just 0.05%. The idea behind the cut is that banks will borrow from the ECB and pass on cheaper loans to European businesses, allowing them to expand and so drive the economy to renewed growth and improved employment prospects. Time will tell. The problem is that rates have been at historically low levels for a long time yet the cash has not flowed to businesses so far. Businesses will not invest unless they are confident that market conditions are favourable for expansion (i.e. that demand exists or will do so shortly).
Inevitably, a cut in interest rates has put pressure on the Euro which has fallen against other major currencies (since the return on Euro holdings has been reduced). This may be a short-lived effect since the return on Euro holdings was already pretty meagre and should the measures prove effective, the currency is likely to rally anyway. The Euro slipped to $1.2931 yesterday, its lowest rate since July 2013 and currently has recovered to $1.2955.
Another measure announced by the ECB is the purchase of debt vehicles from banks (mainly securitised private loans) which ought to help to support them. Mr Draghi noted: “The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABS) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme. This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter.”
The ECB further discouraged banks to hold fund with it by cutting its deposit rate from -0.1% to -0.2% (i.e. banks now have to pay twice as much to leave funds on deposit at the ECB).