European Bank Cuts Rate, but Signals It Has Limits

For now, at least, the bank remains unwilling or unable to wield the more powerful weapons that many economists say are needed to jolt the Continent out of recession. Although the big fear last year that the euro zone might break apart has receded, the danger now could be prolonged stagnation like that which has plagued Japan for most of the last two decades.

Even the traditionally conservative Bank of Japan has become bolder lately, aggressively buying government bonds to try to double the supply of money in circulation and spur growth. Such a step would be unthinkable for Mr. Draghi, who is hemmed in by the bank’s narrower mandate and the historically rooted inflation fears of Germany, the euro zone’s wealthiest and most politically powerful member.

The bank’s Governing Council, meeting in Bratislava, reduced its benchmark interest rate to 0.5 percent from 0.75 percent. But that move was widely seen as mostly symbolic, to avoid the impression that the bank and Mr. Draghi were doing nothing as the euro zone recession threatens to engulf countries, like Germany, that have previously been spared.

The central bank also extended its promise to provide banks with as much cheap cash as they need through 2014, and said it was exploring ways to use the European Union’s house bank to stimulate lending to small businesses.

Intriguingly, Mr. Draghi raised the possibility of imposing a “negative rate” on the deposits that banks routinely park at the central bank, essentially charging banks to store their money. That might discourage lenders from hoarding cash rather than lending. But it could have unintended consequences. For example, banks might store huge amounts of paper bills as a low-risk alternative to central bank vaults.

Mr. Draghi insisted that the rate cut, which takes effect May 8, would stimulate growth, especially now that the economic slump that has afflicted Spain and Italy for more than a year is spreading north to countries like Germany, Austria and Finland. Anticipating skepticism, he urged reporters “not to underestimate the impact” of the rate cut and other measures at his news conference on Thursday, under a crystal chandelier in an ornate building that houses the Slovak Philharmonic. It was one of the central bank’s twice-a-year meetings in the capital of one of its member countries.

Not only is the central bank avoiding Japanese-style shock therapy, but it remains far from pursuing any equivalent of the so-called quantitative easing that the United States Federal Reserve Board and the Bank of England have used to stimulate their economies.

“The bright minds in the Eurotower are still working hard to come up with a new magic bullet,” Carsten Brzeski, an economist at ING Bank, said in a note to clients, referring to the central bank’s headquarters in Frankfurt. “In the meantime, the only thing Draghi found in his tool kit was an old tool and a chill pill to keep markets happy in the waiting room.”

Under the euro zone’s political structure as a loose confederation, the European Central Bank does not have the monolithic power of the Fed, Bank of England or Bank of Japan. Even if Mr. Draghi and some others on the 23-member Governing Council wanted to do more to spur growth, they are hamstrung by a charter that obliges the bank to defend price stability above all else and forbids it from providing financing to governments.

Mr. Draghi has at times been willing to stretch that mandate. Last summer, for example, he promised to buy government bonds in unlimited amounts to control borrowing costs. His expression of resolve has been enough to keep speculators at bay and tamp down the interest rates on Spanish and Italian debt, without any actual bond purchases.

Mr. Draghi also must contend with the politics of the central bank’s Governing Council, which includes the heads of all 17 national central banks in the euro zone. Germany, in particular, remains staunchly opposed to bond buying or other aggressive measures to stimulate growth, for fear of inflation.

Article source: http://www.nytimes.com/2013/05/03/business/global/03iht-euro03.html?partner=rss&emc=rss