European Central Bank & Bank of England Cut Interest Rates
by Rebekah Manning
European Shares Down as ECB Cuts Rates to 1.5 pct
On Thursday, The Bank of England and the European Central Bank took aggressive but anticipated action reducing their rates to record lows of 0.5% and 1.5% respectively. European markets responded coolly to the news as shares fell steadily lower by midday.
England’s Monetary Policy Committee (MPC) did not stop with their rate cut. In desperate efforts to encourage lending and ease the country’s credit markets, the “MPC has acknowledged the cuts may still not be enough and now has moved on to quantitative easing. Buying assets worth 75 billion sterling could be a positive sign,” reported Mike Lenhoff of Brewin Dolphin.
The mild response may have been predicated upon a reduction in the amount of anticipated cash infusion. Preliminary reports had indicated that 150 billion pounds or $212 billion would be forthcoming. The government’s investment is expected to take place as early as Friday.
The European Central Bank (ECB) does not have a practical process to utilize quantitative easing. It is expected that the rate cut will accomplish little in relaxing the stressed housing and business credit markets throughout Europe.
The cuts were released at the same time as the Euro zone GDP indicated a larger than expected decline in the fourth quarter. The GDP fell by 1.5% on top of a previous quarter loss of 0.2%. European markets are looking to the U.S. to stabilize and news of General Motors’ disappointing audit and possible bankruptcy seemed to outweigh actions by the Bank of England and the European Central Bank.
Behind the Interest Rate Cut Remedy
Structurally the Bank of England and the European Central Bank face differing problems. With 16 member nations participating in the European Central Bank, the overriding issue is where to begin to bolster Europe’s paralyzed credit markets. The Bank of England only answers to itself and has used this flexibility to pose dramatic programs to encourage lending.
The Bank of England has postured itself for government approved quantitative easing. The Bank is hoping that by combining this strategy with the interest rate reduction to the record low at 0.5%, the country’s banks will be encouraged to increase private sector lending.
England’s Treasury Chief, Alistair Darling, has indicated that the government would begin infusing cash as early as this week. Quantitative easing is the process by which the supply of money is expanded. The Treasury will be creating 75 billion pounds or $106 billion and buy assets from troubled banks. The hope is that the creation of this new money will open up credit markets for homes and businesses throughout the country. The risk is that the banks will hold the money and not confront the credit freeze.
While the European Central Bank took action to lower their interest rates, quantitative easing is not a viable option. With 16 members, there exists no formula for identifying possible national assets the Central bank could purchase. Europe’s Central Bank does not have the luxury of purchasing government bonds, and the ECB fears claims of favoritism by purchasing assets of a particular member nation.
While the European Bank lowered interest rates to an all-time low of 1.5%, Europe seems handcuffed to respond to its pressured credit markets. Meanwhile, housing markets and business credit markets are expected to remain at crisis levels throughout Europe.
What is the Next Step for the Eurozone and Britain?
The ECB acknowledged the plight of the credit crunch. A statement by ECB president Jean-Claude Trichet revealed that the bank was considering sweeping and “substantial” new measures to increase bank liquidity throughout Europe. To date, actions by the ECB have been ineffective in opening up the credit markets as the recession moves deeper into European housing and business fronts.
Thus far, the ECB has been reluctant to purchase debt, but that measure could be in the near offing. Trcihet is comfortable with the rate of inflation while the actions by the Monetary Policy Committee in England have raised the cautionary inflation red flags. Both England and Europe confirm that the current recessionary crisis will hold firm through 2009 and well into 2010.
Meanwhile, stressed homeowners and business owners see no future. Without drastic credit relaxation, unemployment is sure to rise as production falls. Foreclosures continue to rise at record rates as values tumble and household income diminishes.
Compounding the European problem is a new report from J.P. Morgan stating that banks in Central and Eastern Europe will require between 32 and 40 billion euros before the end of 2010 to stay afloat. Morgan estimates that non-performing loans will approach 30% in this time frame and that loss ratios will near 75%.
While England’s actions are comparable to the Obama administration’s stimulus package, the inaction by the ECB is cause for concern. To get economies moving and keep the population in their homes, stimulus programs seem the logical move.
Tags: Bank of England, ECB, Economy, interest rates
About the Author - Rebekah Manning
Rebekah started in the Forex industry as an intern in 2001, and worked her way up the ranks to a C-level management position. She enjoys the field of trading as well as MMA fighting, shooting ranges, and action movies.
