ECB May Reduce Deposit Rate to Stimulate Bank Lending

By Gabi Thesing

Dec. 18 (Bloomberg) -- The European Central Bank may cut its deposit rate as soon as today in an effort to jolt banks into lending more to each other, economists said.

President Jean-Claude Trichet and his governing council meet in Frankfurt after signaling this month they may soon lower the 2 percent rate they pay on cash stashed overnight at the bank by financial companies. They want to encourage banks to lend more and free up capital for consumers and companies. The ECB usually announces any decisions at its mid-month meetings after 1:30 p.m.

“Today’s meeting would be the perfect opportunity to slash the deposit rate given they’ve talked about it so much,” said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc. “The ECB might think it’s the only way to take away banks’ incentive to park the money with it and not lend to each other.”

Trichet and other officials are concerned that following the Federal Reserve and cutting the benchmark rate close to zero won’t revive the economy as long as banks are hoarding cash.

Overnight deposits at the bank have surged since mid- October, when the ECB started offering lenders unlimited cash in its weekly refinancing operations. Deposits climbed to 200.4 billion euros ($288.6 billion) yesterday, almost four times the daily average of 534 million euros in the year through Sept. 15. They reached a record 297.4 billion euros on Nov. 6.

Lehman Collapse

While the ECB has lowered its main rate three times since early October, taking it to 2.5 percent, banks remain risk- averse three months after the collapse of Lehman Brothers Holdings Inc. That’s deepening a recession that began in the second quarter by depriving companies and households of access to cash.

The euro interbank offered rate, or Euribor, which banks say they charge each other for three-month loans, fell 4 basis points to 3.16 percent yesterday, the lowest since August 2006, European Banking Federation data showed. That’s still 66 basis points more than the ECB’s benchmark rate. The gap averaged 15 basis points in the seven years to August 2007, when the credit crisis began.

Trichet said Dec. 15 that lowering the deposit rate “is an idea that is being examined.” Executive Board member Lorenzo Bini Smaghi said Dec. 5 that the “ECB may start thinking about measures that would help reactivate the money market, such as re-widening” the gap between the bank’s main and deposit rates. The ECB cut that spread in half to 50 basis points on Oct. 9.

Policy ‘Telegraphed’

Policy makers “have basically telegraphed that they are going to cut the deposit rate, so I would expect something today,” said James Nixon, an economist at Societe Generale SA in London and a former forecaster at the ECB.

The bank will need to reduce the deposit rate by at least a percentage point to have an effect, given banks may not be sensitive to it, Cailloux said.

Bundesbank President Axel Weber told Dow Jones yesterday he would caution against an “isolated reduction in the deposit rate” as it wouldn’t ease banks’ concerns that rivals may have solvency problems.

The ECB may also want to delay a cut until January so lenders aren’t unnerved as they close their books at the end of the year, said Laurent Bilke, an economist at Nomura International and a former ECB forecaster.

Interbank Market

“If everything goes well and the situation doesn’t deteriorate, they could take such steps at the next meeting” on Jan. 15, he said.

Policy makers are also studying whether to have the ECB take control of the interbank market and act as a clearinghouse for lending between banks. ECB Vice President Lucas Papademos said Dec. 15 it’s “a concept worth studying.”

While lowering the deposit rate and introducing a clearinghouse would be “very powerful tools to get the banks lending again,” that won’t save the ECB from having to lower its benchmark rate again next year, said Aurelio Maccario, chief euro-area economist at UniCredit Group in Milan.

The Fed this week reduced its main rate to near zero, yet ECB officials including Trichet have said there’s a limit to how far they can cut their benchmark and signaled policy makers may pause in January.

The European central bankers are “stupid if they think” paring the deposit rate “will help them avoid having to speed up the size and pace of rate cuts after what the Fed did,” said Nixon.

To contact the reporter on this story: Gabi Thesing in Frankfurt at gthesing@bloomberg.net