In the euro zone, the ECB reduces the interest rates once more.
The Old Lady of Threadneedle Street, better known as the European Central Bank (ECB), pulled out the rate-cutting scissors once again. The key lending rate, where banks park their extra dough at the Central Bank overnight, dropped by a sliver of 0.25%, now resting at a cozy 3.5%.
As the specter of deflation loomed less intimidatingly, the ECB revisited its monetary policy, conducting a policy U-turn back in June. The key lending rate, a temporary home for banks' overflowing liquidity, has been scaled back. This nostalgic trip to lower rates was anticipated by the economic forecasters.
Simultaneously, the ECB Council remained tight-lipped on the subject of future monetary policy moves, just a handful of weeks before their October rendezvous: "The ECB Council leaves no trail of commitment regarding a predetermined path for interest rates."
Jörg Asmussen, the CEO of German Insurance Association, applauded the rate reduction as a refreshing indicator of confidence for the markets. However, he stressed the need for the ECB to maintain its finesse. Persistent inflation in the service sector hinted at a stubborn inflation percentage responsible for perpetuating itself in the future. Criticizing the timing, Asmussen emphasized the importance of the ECB not skipping the beat for further rate movements.
Main refinancing rate takes a more significant plunge
The staple refinancing rate, at which banks acquire loans from the ECB for a week, slumped by a more substantial 0.6%, now settled at 3.65%. The fall is more pronounced than the deposit rate decrease due to previous decisions made by the ECB in the spring. In the spring, it tightened the ranks between the deposit and main refinancing rates, intending to generate incentivizes for banks' participation in weekly loan operations and limit market interest rate flirtations.
If market interest rates see too much turbulence, the intended monetary policy message from the Bundesbank President Joachim Nagel might get garbled, impacting its overall effectiveness. Nevertheless, the deposit rate remains the essential monetary policy rate as it lays down the groundwork for the money market – establishing its lowest interest rate for inter-bank lending.
Banks in Euroland still possess a hefty chunk of around 3 trillion EUR in additional liquidity they can stash at the ECB. As the years pass, this surplus is likely to dwindle, causing banks to look towards the ECB for loaning needs. The narrower interest spoon they offer helps the ECB better manage market interest rates.
Lower interest rates for instant or fixed-term savings
The interest rates for corporate borrowing are expected to plunge in a more appealing fashion, while instant or fixed-term savings will return less. Prior to the June policy U-turn, the Central Bank kept interest rates elevated in its battle against inflating costs in the Eurozone.
The reduction in energy prices slashed the inflation rate to 2.2% in August – its lowest level since October 2016. The economists at the ECB predict that overall inflation in the Eurozone will rest at 2.5% in 2022 and slip to 2.2% by 2027. By 2028, it's projected to touch 1.9%.
ECB economists assert that inflation will rise again later this year. Most of this resurgence can be traced back to the former dramatic declines in energy prices exiting from the yearly calculus: "Inflation will subsequently trend towards our targeted value in the second half of next year."
The Central Bank predicts economic growth in the Euro zone for 2022 to stand at 0.8%. It projects 1.3% growth for 2027 and 1.5% for 2028. In June, ECB experts predicted 2024 growth of 0.9%, 2027 growth of 1.4%, and 2028 growth of 1.6%.
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Given the improved economic outlook, the ECB decided to lower the main refinancing rate, which banks use to acquire loans from the ECB for a week. The rate decreased by a significant 0.6%, now sitting at 3.65%. This move is expected to result in lower interest rates for corporate borrowing, while returns on instant or fixed-term savings will decrease accordingly.
As a result of the ECB's policy changes, banks in Euroland will have less incentive to participate in weekly loan operations, as the difference between the deposit and main refinancing rates has narrowed. This could lead to market interest rate fluctuations, potentially affecting the ECB's overall monetary policy initiative.
