The European Central Bank Stimulates Investment Activities in the Euro Area

On June 5, the European Central Bank reduced the key interest rate by 0.1 p.p. fr om 0.25% per annum to 0.15% per annum, as well as the overnight deposit rate from 0% to -0.1% per annum. The lending rate decreased from 0.75% per annum to 0.4% per annum.

For the first time in the history of the euro area, the rate on deposits fell below zero. Such a decision by the European monetary authorities was expected. The applied measure is aimed at motivation of lending activities by banks in conditions of higher risks of deflation, slow economic growth rates and growth in the rate of unemployment in the euro area.

It is to be reminded that the deposit rate in the euro zone was at the zero level from July 2012, which situation permitted the European Central Bank to reduce banks’ deposits from euro 800bn to euro 30bn in spring 2014. A negative rate on deposits represents a fee for placement by commercial banks of available reserves -- which are not involved in a monetary multiplication process – in one-day deposits with the European Central Bank. The above measure can serve as motivation for some growth in volumes of lending by European banks to industry. In addition to the above, the negative interest rate – justified by potential weakening of the euro – has a particular psychological effect. However, if in response to the above measure commercial banks increase the cost of their services and cut the rate on retail deposits, it is not necessarily that there will be growth in lending volumes and the rate of inflation.

To all appearances, further motivation of investment activities in the euro area will be carried out with utilization of nonstandard measures of monetary policy. In autumn 2014, European Central Bank is going to launch a program of extension of long-term loans which measure permits to open new credit lines for the real sector.

It is to be noted that the reaction of currency market participants to easing of the monetary policy by the European Central Bank is not quite clear yet. Despite a sudden 0.25% depreciation of the euro exchange rate against the US dollar to $1.35 per 1 euro after the official declaration of cuts in interest rates, by the end of the day of June 5 the euro reached the level of $1.37 per 1 euro. In the mid-term prospect, the situation wh ere European assets become less attractive due to interest rates cuts will put downward pressure on the euro exchange rate, thus, raising competitive edge of European goods.

It is to be reminded that in Q1 2014 economic growth rates in the euro area amounted to 0.2%, while in April the level of the rate of unemployment despite the downward dynamics was equal to 11.7%. In May, the annual inflation rate fell to 0.5% with the target level of 2%. In such a situation, the stimulus measures of the monetary policy appear justified.

Pavel Trunin, PhD (Economics), Director of the Center for Macroeconomics and Finance,
Alexandra Bozhechkova, Researcher