The interest rate in the eurozone has been cut to a record low of 0.5% by the European Central Bank (ECB) amid continuing worries about the eurozone's economic health.
The quarter point cut downwards from 0.75% was widely predicted in the wake of the latest flare-up in the eurozone crisis following the Cypriot rescue and after earlier official economic data, released on Tuesday, showed manufacturing activity across the 17-nation eurozone contracted in April. Germany, the zone's biggest economy by far, saw manufacturing fall for the second month running.
The reduction in interest rates across the single currency bloc is the first in 10 months and indicates that the European economy is still mired in debt and stagnant growth at best, with many southern European nations experiencing high unemployment and falling gross domestic product (GDP) figures. Inflation is also at a three-year high.
The outlook means that many European treasurers will continue to sit on cash reserves, or struggle to obtain funding if they are a smaller firm, and adopt a risk-averse outlook for the foreseeable future.
The need for ECB action to support the eurozone economy was clear. The central bank’s president, Mario Draghi, commented at the announcement of the rate cut yesterday that, "weak economic sentiment has extended into the spring of this year and inflation expectations in the euro area continue to be firmly anchored.
“The cut in interest rates should contribute to support a recovery later in the year," he optimistically added.
Draghi also said, “monetary policy stance will remain 'accommodative' for as long as is needed,” and that the ECB will, “monitor very closely all incoming information, and assess any impact on the outlook for price stability."
The ECB was prepared to cut interest rates still further should conditions make it necessary, he continued, while adding it was "technically ready" for negative deposit rates.
Negative Deposit Rates
Draghi’s comments, and the wider eurozone economic picture, caused the euro to fall initially on the financial markets. It lost 0.6% against the pound to 84.135p yesterday, edging it towards the historic low of 83.98p that it reached last month. Against the dollar, the euro fell below $1.31 but then recovered. The changing price should alert treasurers alive to foreign exchange (FX) exposures and risk, but some of the lost currency ground was recovered after the full extent of the ECB bond-buying support to the eurozone economy was factored in by the markets.
Nonetheless the ECB talk of negative deposit rates is bound to spook treasurers who are already struggling to gain a return for their corporations in a low interest rate environment. The recent uptick in the issuance of debt conversely shows that it can have treasury benefits too for those firms, such as Apple, that want to raise cheap money to launch shareholder buybacks or to invest.
PMI Index Confirms Shrinking Eurozone
The Purchasing Managers' Index (PMI), which was released prior to the ECB interest rate cut on Thursday, confirmed the generally gloomy economic outlook for the single currency bloc. The PMI for German manufacturing sector, which accounts for around a fifth of the eurozone’s economy, fell to 48.1 in April from 49 in March. A reading below the 50 mark is considered to indicate contraction in the renowned index, which is collated by Markit.
In Italy, France and Spain, the eurozone's next three biggest economies, the PMI data also showed reductions in manufacturing activity. The PMI for the bloc as a whole fell to 46.7 last month, from 46.8 in March.
There are concerns that the ECB's low interest rates are still not feeding through to those economies most in need of a boost, with Greece and Spain of particular concern, which is why a further cut was inevitable.
Austerity to End?
The austerity measures that many European economies have adopted in recent years to cut surging government deficits are also now beginning to come under attack as the search for growth intensifies via stimulus packages. The French President, Francois Hollande, and the newly-elected Italian Prime Minister, Enrico Letta, have both called for the end to austerity policies, but their room for manoeuvre is constrained by the markets and their own government finances.
The European Council President, Herman Van Rompuy, added to the pressure for change when he declared before the ECB interest rate cut that governments must take immediate action to promote growth and jobs because patience with austerity measures is wearing thin with European citizens.
“Taking these measures is more urgent than anything," he told the BBC at a Portuguese conference. "After three years of firefights, patience is wearing thin."