ECB May Be Forced to Cut Deposit Rate Further

By Simone Meier

Nov. 7 (Bloomberg) -- The European Central Bank may be forced to lower its deposit rate further if banks continue to park record amounts of cash with it overnight, economists said.

``That's the only way to take the incentive away and put the money back into the system,'' said Jacques Cailloux, chief euro- area economist at Royal Bank of Scotland Plc in London. ``They'll wait to see whether there's an improvement over the coming days, but it has started to become an issue.''

Overnight deposits have exceeded 200 billion euros ($255 billion) for 16 of the past 17 working days, showing banks remain reluctant to lend to each other even after the ECB flooded the banking system with cash and cut interest rates. While money- market rates have declined, deposits yesterday surged to a record 297.4 billion euros. In the year to Sept. 15, deposits with the ECB averaged just 534 million euros a day.

``The ECB is certainly not happy with the fact that banks are still depositing huge amounts of cash,'' said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. ``It could only be a matter of days'' before they act.

The ECB yesterday announced its second rate reduction in less than a month and President Jean-Claude Trichet declined to rule out lowering the deposit rate even further. While the rate will fall to 2.75 percent from 3.25 percent on Nov. 12, when the latest cuts take effect, the gap with the new benchmark rate of 3.25 percent will remain 50 basis points.

Narrowed Gap

The ECB narrowed the gap from 100 basis points on Oct. 8 as part of a range of emergency measures designed to ease pressure on banks. The next day, overnight deposits more than doubled to 155 billion euros.

Money-market rates have declined as central banks pump record amounts of extra cash into the system. The euro interbank offered rate, or Euribor, that banks charge each other for three-month loans fell 12 basis points to 4.47 percent today, the lowest level since March 6, according to the European Banking Federation. The one-month rate declined 15 basis points to 4.10 percent.

Still, the ECB ``seems to be the only place where you can put money and know you won't lose it,'' Cailloux said.

Lending between banks ran dry after Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, shattering confidence and sending borrowing costs to records. Financial institutions worldwide have reported more than $690 billion in losses and writedowns since the U.S. housing slump triggered the credit crisis last year.

To contact the reporter on this story: Simone Meier in Frankfurt at smeier@bloomberg.net