Could interest rates in the Euro area go any lower?

Last Thursday, the European Central Bank (ECB) cut interest by 0.25 per cent to 1.25 per cent, falling short of analysts’ expectations of another 0.5 per cent rate cut.

Business Today spoke to economic analyst – Labour candidate for EP elections and economist Edward Scicluna, about the ECB’s latest decision, the issue of non-standard measures and whether Maltese banks should cut their interest rates after the latest ECB cut, among other things. Report by CHARLOT ZAHRA.

Edward Scicluna : “Too little too late”

What is your opinion about the ECB’s decision to cut interest rates at a historic low of 1.25 per cent?

Too little too late. The ECB does what some other Central Banks would have done with a bolder cut a month earlier. The overly conservative attitude of the ECB is now well established. What, do you think, led the ECB to exercise caution with cutting the interest rate this time around despite the worsening of the economic crisis in the euro area, especially the inflation figures? The ECB is more reluctant than the Federal Reserve to start using what it refers to as “non-standard” measures to support the Euro zone economy. The tiny and sparse cuts in the interest rates prove that the ECB wanted to take its time before reaching this unorthodox stage, which every central banker dreads. Resorting to quantitative easing and direct printing of money is not a light decision to take. It is still uncharted waters.

ECB Governor Jean-Claude Trichet reiterated his warning of using “non-standard” measures to support the Euro zone economy, saying that the ECB would be discussing the matter next month. Do think that the time is now ripe for non-standard economic measures or not? Why?

Quantitative easing is the term we use which a Central Bank may use in such an eventuality. It is similar to a tourniquet used in first aid; it may stop the haemorrhage but creates dangerous side effects.

The printing of money sends shivers down the spine of any central banker. Can you imagine the European Central Bank getting to that stage in a country like Germany – where hyperinflation is likened to a volcano exploding in the middle of the town? Memories are hard to be forgotten. On the other hand, the downward risks are still there in spite of seeming observations of traces of an economic uplift on the horizon. Economic activity and asset prices are falling at a lesser rate. But one still needs to use all the monetary and fiscal instruments at one’s disposal to stop this dangerous beast. The 1930s devastation happened only 80 years ago. The stages being reached are still very similar. That’s why it is so scary. The G20 meeting has to be seen in this perspective.

Last month, Maltese banks did not pass on the full interest rate cut to clients, claiming that they wanted to protect depositors. In view of the current crisis facing the Maltese economy, do you agree with the banks’ approach? Why?

The fall in the central interest rates have stopped being effective because the banks are no longer responding in sympathy. Today’s banks are upping their rates rather than lowering them. The reason is simple to understand. Interest rates include a risk element. That risk element is increasing and the cautious and correct banks want to reflect it in their lending rates. And that is why soon the Central Banks have to do what the Japanese did in their decade long recession – quantitative easing.

In your view, should they now pass the full interest rate cut to their consumers, especially since the rate cut is smaller?

Governments may use cajoling, suasion and similar methods to get banks to respond to ECB rate changes. But there is a limit to what they can do.

Business Today | Wednesday, 08 April 2009

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