The European Central Bank’s (ECB) decision to cut interest rates and to buy private sector loans is a belated move to reduce the risk of deflation in the euro area, and to revive its ailing economy. As inflation fell to 0.3 per cent in August, and the rate of economic growth contracted in the second quarter, the ECB was forced to step in and to provide some stimulus. The ECB’s mandate requires it to meet a target rate of inflation “below, but close to 2 per cent”. But the bank’s failure to do so over many months only served to raise public expectations of deflation, which would further depress growth.
The compromise agreed by the bank's governing council was the best that ECB president, Mario Draghi could secure in the circumstances, as divisions emerged between council members on what policy approach to adopt. The monetary stimulus proposed by the bank will further weaken the euro – which has been overvalued for too long. This will give Irish exporters to the US and UK markets a competitive boost. Since June the euro has dropped 5 per cent in value against the dollar, and the currency should continue to weaken as the American economy strengthens – with US interest rates set to rise next year.
The ECB by buying private loans from banks, should help to make credit more widely available. Banks that sell loans to the ECB will find themselves better placed to lend more to households and to businesses that up to now have had limited access to finance. In that regard, the ECB’s willingness to buy residential mortgages could provide a boost to the domestic banks and also help to increase the supply of credit for the housing market.
Two years ago Mr Draghi proposed an ECB initiative and promised to do "whatever it takes" to save the euro. His words then had a transformative effect on financial markets, which both ensured the currency avoided speculative assaults, and greatly helped peripheral economies – including Ireland – to make a strong recovery. One disappointing development has been the ECB's concern about the Government's plans to refinance the State's borrowing from the International Monetary Fund, which would result in substantial savings. The ECB is concerned at what it regards as the slow pace at which the Irish Central Bank is selling the long-term bonds, which it acquired in exchange for the Anglo-Irish promissory notes earlier this year. When Minister for Finance, Michael Noonan meets the ECB president next week in Frankfurt, the extent of the bank's opposition should be clearer. One other difficulty yet to be overcome, however, is the requirement that early repayment of IMF loans also requires the approval of all the other EU lenders who participated in the bailout agreement. That too could prove hard to obtain.
