ECB’s Draghi ‘ready to act’ but the problems get worse

After all the speculation, the European Central Bank (ECB) did
announce an interest rate cut to 0.5 per cent, a new low for
the eurozone. It was the first cut in ten months and signals
the central bank’s acceptance that things are not looking as rosy
in the single currency as they had hoped.

ECB president Mario Draghi said “weak economic sentiment has
extended into the spring of this year”. He added: “Inflation
expectations in the euro area continue to be firmly anchored.

“The cut in interest rates should contribute to support a
recovery later in the year.”

But what really sparked the
currency exchange markets into life was Draghi’s comments on
negative deposit rates.

Although he noted that there could be “several unintended
consequences” from a negative deposit rate, Draghi said the central
bank will look at this with “an open mind” and “stand ready to act
if needed”.

The comments sent the euro plunging more than one per cent
against the dollar, with EUR/USD dropping below 1.32, while the
pound edged up 0.6 per cent versus the single currency.

Negative deposit rates would mean banks would have to pay the
ECB for holding euro deposits. Such a move is designed to encourage
banks to lend to businesses, but it could also drive money out of
the eurozone and into other higher-yielding assets.

However concerns remains about whether any of these measures
will work. Jörg Asmussen, an ECB executive board member,
articulated these worries recently. “Monetary policy is not an
all-purpose weapon for any kind of economic illness,” he said. “Due
to impaired monetary policy transmission, the pass-through of rate
cuts to the periphery would be limited, and this is where they are
most needed.”

Meanwhile, the eurozone economy stumbles on without any signs of
a meaningful recovery. Unemployment in the bloc surged to a
fresh record high, while inflation has fallen to a three-year low.
The jobless rate in the 17 countries using the euro hit 12.1 per
cent in March. In Greece the unemployment rate is 27.2 per cent,
while the figure for Spain is 26.7 per cent. Separate Eurostat data
showed inflation slowed to 1.2 per cent in April.

Figures for the eurozone’s manufacturing sector do not get any
better. Germany’s key manufacturing PMI fell to 48.1 in April
from 49 in March, with anything below a 50 indicating contraction.
Manufacturing activity also plunged in France, Italy and Spain.
Overall, the PMI index for the eurozone fell to 46.7 last month,
from March’s 46.8.

“There is nothing here to suggest that manufacturing will turn
the corner and stabilise any time soon, putting greater onus on
policymakers to act quickly to reinvigorate growth,” said Chris
Williamson, chief economist at Markit.

Finally, troubles in Slovenia rumble on, with the country
suffering a downgrade to its credit rating amid warnings it could
become the latest eurozone country to need a bailout package.

“Slovenia’s vulnerability to external shocks, like those brought
about by the crisis in Cyprus, could make it difficult for the
sovereign to fund itself at sustainable rates, which increases the
likelihood that authorities would need to request an external
assistance program,” said rating agency Moody’s.