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ECB readies negative interest as deflation assault

The ECB effectively announced its latest round of interest rate cuts at last month's policy meeting. The goal is to tackle deflation by strong-arming banks into lending money. Good for borrowers, but what about savers?

Mario Draghi was set to fire perhaps the last ammunition in his arsenal against deflation on Thursday at the European Central Bank's policy meeting. The ECB president was expected to further decrease record-low interest rates, in response to persistently-high eurozone unemployment and slow inflation.

The ECB offers three baseline interest rates for European banks, all of which are currently at record lows: 0.75 percent, 0.25 percent and 0, respectively.

The lowest of the Frankfurt-based bank's three rates, the deposit facility, was likely to be moved into negative territory for the first time ever. The deposit facility is the rate which banks receive for depositing funds with the ECB on a short-term basis. A negative rate would effectively mean that banks would be paying for this service; the idea is to encourage them instead to lend out the bulk of their reserves to small- and medium-sized companies.

"In theory, the combination could provide a powerful cocktail that boosts bank lending. But negative deposit rates have not been used at this scale before and could have unpredictable consequences," Berenberg Bank economist Christian Schulz told the AFP news agency.

ECB President Draghi said

at last month's policy meeting

that the central bank was "comfortable with acting," and noted "low inflation and weak economic activity is a cause for serious concern."

An inefficient weapon to date

Low interest rates - which encourage lending and borrowing, while making savings accounts virtually worthless - are considered the prime weapon against deflation, sustained overall price drops across key products.

The ECB will tolerate an inflation rate of around 2 percent, defining this as price stability. Currently, Europe's economies doggedly refuse to even approach to these levels. Inflation for the eurozone as a whole slowed to 0.5 percent in May. This comes despite the ECB providing some of the lowest interest rates ever for most of the past five years since the so-called financial crisis.

A major perceived danger with deflation is that it can prompt businesses and people to suspend their spending, in the hope that prices continue to fall. This resultant lack of consumer and business activity only exacerbates the problem, which can become very difficult to reverse.

A common criticism of the ECB's current economic policy, however, is that banks generally can be better relied upon to pass the low interest rates on to savers than to borrowers. Most simple savings accounts now reflect the near-zero returns on hoarded wealth, although borrowing rates are markedly higher than those offered to banks by the ECB.

msh/dr (AFP, dpa)

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