Mere symbolism?

It's a truly historic date. For the first time since the euro currency was introduced back in 1999, the European Central Bank (ECB) has set an interest rate of less than 1.0 percent on its loans to banks across the eurozone. Yes, markets had been hoping for such a move. And yes, many economists would like us to believe that a rate cut will kick-start growth on the continent. But growth policy just can't be replaced with monetary policy.

Markets will soon get back to business as usual, and the debt crisis and fears of recession are bound to stay with us. This is because the bank's decision is not much more than a mere signal that says, "Look, we've done our homework and improved the conditions for financing both banks and the economy as a whole." So the trough is filled, but it's up to the horses to drink.

Small gain

But whether they will or not is anyone's guess. Europe is mired in stagnation and recession - at least in some regions. Many companies are insecure and hesitant as to how to proceed. Their investment decisions hinge on sales prospects - rather than on whether loans are cheaper by 0.25 percentage points. But sales prospects have been deteriorating of late, also in the German economy.

And so the interest rate cut will hardly trigger an investment boom. But it won't do much harm either. There was a time when economists used to warn against inflation pressures every time the ECB lowered its rate. These days no one does that anymore. That's simply because companies won't be able to raise prices at a time when the economic environment in Japan and the US seems very fragile and when formerly booming emerging economies are having to grapple with sinking growth. Not to mention Europe with its fears of recession.

Small damage

No growth incentive expected, and no heightened inflation pressure either - so what's all the fuss about then, one might ask. The answer may lie in the banking sector: the ECB's move may be interpreted as a small, disguised boost for ailing lenders. After all, it's unlikely that the banks will pass on the rate cuts to their customers.

If the banks can get hold of cheaper money while charging the same, interest yields will increase. And higher profits can go towards raising the banks' core capital in line with the requirements of the Basel III banking rules. They could also go towards softening the impact of writedowns on toxic assets.

Seen in this light, it seems only logical that the ECB has lowered its rate for its overnight storage facility which gives banks the opportunity to park their excess resources. And lenders have made ample use of that facility. That rate was also cut by 0.25 percentage points, to reach zero points. In other words, it's now even less rewarding to park a lot of money at the ECB. It may be wiser to lend it to the real economy. If this happens on a larger scale, the ECB could at least be credited with heading off a possible credit crunch. What it can't do, though, is to help the economies get on their feet again. All in all, Thursday's rate cut can only be viewed as psychological encouragement for the markets - not more and not less.

Author: Rolf Wenkel / hg
Editor: Michael Lawton