ECB set to cut rates again as crisis deepens

FRANKFURT (AFP) ― The European Central Bank is expected to cut its key interest rates for the second time in two months next week as EU leaders battle to find a solution to the long-running debt crisis.

The ECB’s decision-making governing council is holding its last monthly interest-rate meeting this year on Thursday, the same day as European Union leaders gather in Brussels to find ways out of a crisis that is threatening the very existence of the single currency.

Many governments and analysts see the ECB as the sole institution capable of putting out the fires of the crisis in the immediate term. But the bank’s new chief, Mario Draghi, has repeatedly stressed its fire-fighting role is only temporary and it is ultimately up to member countries themselves to get their finances in order.

Draghi surprised the markets when he took over at the ECB’s helm only last month with an immediate quarter-point reduction in borrowing costs as the 17 countries that share the euro teeter on the brink of a new recession.

And markets and ECB watchers are penciling in a similar move again this month, bringing borrowing costs in the euro area down to just 1.0 percent.

While Marco Valli at UniCredit believed that such a move was “not a foregone conclusion, because in the past the ECB rarely moved at two consecutive meetings without facing a major shock ... our view is that, under current circumstances, there is not much merit in delaying rate action.”

With the ECB’s latest staff economic projections, also scheduled for publication on Thursday, expected to be revised downwards significantly, the bank will have ample arguments to justify a further rate cut, said Commerzbank economists Michael Schubert and Ralph Solveen.

This “should prompt the ECB to cut its refi rate from currently 1.25 percent to 1.0 percent,” they predicted.

Thus, with such a move already widely priced in, the focus of attention will be on the so-called “unconventional measures” that Draghi will announce to try and get the crisis under control, analysts said.

Tensions in the sovereign bank markets appear to have eased slightly in the last few days.

Nevertheless, signs of strain in the banking sector “have grown, with interbank interest lending rates rising and banks placing more money on deposit with the ECB instead of lending to each other,” said Jennifer McKeown, senior European economist at Capital Economics.

Another sign that banks are increasingly hoarding liquidity came when the ECB failed to “sterilize” or mop up the extra liquidity it has pumped into the markets via its controversial program of buying the bonds of distressed countries.

One possible answer to this could be for the ECB to extend the maturity of liquidity-providing operations from currently one year to two or three years.

And the beneficial impact of such a move could be maximized by relaxing the rules on collateral, argued Valli at UniCredit.

Overall, analysts are convinced the ECB is preparing to take more aggressive action. But it likely to make that conditional on EU leaders adopting a much tighter fiscal framework, possibly at their December 8-9 summit in Brussels, analysts argued.

That certainly appeared to be Draghi’s message when he said in Brussels last week: “Other elements might follow, but the sequencing matters.”

Holger Schmieding, chief economist at Berenberg Bank, was not convinced, however, seeing only a 1-in-3 chance “that the December summit and a more active ECB thereafter can turn sentiment around for good.

“That leaves a probability of 2 in 3 that the summit will again relieve tensions only temporarily,” Schmieding warned.

“Our central case remains that the crisis will escalate again thereafter until, probably some time in January, the ECB and the Bundesbank (the German central bank) finally realize that they have no further option but to intervene (much more) aggressively,” he concluded.