Tuesday 20 March 2018

Pressure grows on ECB to cut interest rates

Eva Kuehnen

LENDING to European firms contracted in May, quashing hopes that the ECB's mass injections of cheap cash might have kick-started confidence and adding to the central bank's growing list of reasons to cut interest rates next week.

ECB data showed on Friday loans to the private sector fell 0.1pc in May, missing economists' expectations for 0.1pc growth and adding to concerns about limp credit demand.

"That is a worrying sign," said Christian Schulz, economist at Berenberg Bank. "That is a combination of recession, less credit demand, but also signs of a credit crunch in some parts of the euro zone."

Loans to non-financial firms fell by 10 billion euros compared with the previous month after jumping by €7bn in April.

The monthly flow of loans to households was €2bn, down from €7bn.

Societe Generale economist James Nixon said the data showed banks and investors were hoarding the ECB's three-year loans rather than lending the money out.

"We have seen weak data, falling inflation and declining credit, these are all consistent with a cut in interest rates next week," he said.

A Reuters poll showed 48 out of 71 economists expect the ECB to cut rates when it meets on Thursday, with most of them having pencilled in a 25 basis point cut to 0.75pc, where they are expected to stay until at least 2014.

Inflation data on Friday also boosted rate cut expectations, holding steady as expected at a 16-month low of 2.4pc in June.

Although it remains above the ECB's preferred 2pc level, it is expected to drop under it by the end of the year.

Additional ECB data revealed that banks are continuing to use its €1 trillion worth of loans to buy government bonds. Italian banks spent €12.3bn on government debt, twice as much as in the previous month.

More worryingly, figures showed savers and companies pulled their cash out of Greek banks at record pace of 5 percent last month when speculation about the country quitting the euro was at its most intense.


Euro zone leaders surprised markets with steps to address the bloc's escalating debt woes on Friday, agreeing to take action to bring down Italy's and Spain's spiralling borrowing costs and create a single supervisory body for euro zone banks.

Attention is now on the ECB and whether it will play a further role in stemming the tensions beyond the expected cut in interest rates.

"The ECB should do something," Berenberg Bank's Schulz said.

"A more direct intervention in the sovereign bond markets, for instance by putting a cap on the bond yields of solvent sovereigns would be more promising ... but the pain threshold is unlikely to be reached just yet," he added.

ECB President Mario Draghi can expect to be pressed on the topic at the euro area central bank's monthly meeting next Thursday. The ECB is prohibited under EU law to finance governments directly, something Draghi has stressed in the past.

Alongside a rate cut, a Reuters poll showed 19 out of 43 economists thought that at some point the ECB would provide more cheap, long-term loans to banks.

With almost €800bn of ECB-fuelled excess liquidity already in the system and banks hoarding record amounts at the central bank every night, the immediate need for extra cash appears limited.

The ECB's money is pushing up overall funding. Euro zone M3 money supply - a more general measure of cash in the economy - grew at an annual pace of 2.9pc in May, up from 2.5 percent in April and well above a 2.3pc forecast.

Fears about inflation or a massive increase in money supply were not warranted, Berenberg Bank's Schulz said, as loans to consumers - the most relevant economic component at the moment - were decreasing.


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