Why an ECB Rate Cut Could Be Too Little, Too Late

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Cash-strapped corporates and households in the euro zone are not seeing any recovery despite the European Central Bank's (ECB) extensive action, including cheap loans to banks and reductions in interest rates, suggesting the central bank's methods to jump-start the economy are not working.

Global central bank action continues to push peripheral borrowing costs lower. But the support from the ECB has failed to stimulate small businesses and reach households in peripheral nations.

Michael Gallagher, director of research at IDEAglobal told CNBC an ECB rate cut is too little too late and will not benefit businesses in the region.

"At the end of the day, 25 basis points off the refinancing rate is too little too late, it is not going to produce a European recovery," said Gallagher.

(Read More: ECB Rate Cut Just Became Even More Likely)

Gallagher, who provides advice to financial market forecasts to the hedge fund and banking communities, said other kinds of lending to businesses are needed to get liquidity going again.

"I think we have got indication from the ECB that they are looking at an SME (small and medium-sized enterprises) lending program. That is important in the long term, it will produce results, but it is not a macro game changer," he said.

"You need something more radical, whether it is a new set of large LTROs (long term refinancing operations) or even QE (quantitative easing), those are the things that will produce a European recovery," he added.

(Read More: Sharp Euro Zone Inflation Fall, Joblessness Point to ECB Rate Cut)

Borrowing costs in Italy fell to the lowest level since October 2010 on Monday and Spanish, Irish, French and Portuguese bond markets have seen fresh falls in yields in recent weeks.

However the European Central Bank said bank lending to companies remains weak and current low interest rates are not filtering through to small businesses, who are still struggling to access finance.

"The degree of the reported deterioration remained significant in a number of the stressed euro area countries, in particular in Greece and Portugal," an ECB report released last week said.

"With respect to banks' willingness to provide a loan, SMEs in all countries, with the exception of Germany (6 percent), reported, on balance, a deterioration, which was especially strong in Greece (-46 percent), Spain (-38 percent), Italy (-34 percent), Portugal (-32 percent) and the Netherlands (-30 percent)," the report found.

(Read More: ECB Rate Cut Could Bring 'Disappointment')

Spanish lenders have pulled a third of business credit, while Irish banks now lend just half what they once did, the ECB figures show.

Nicholas Spiro, head of Spiro Sovereign Strategy, said there is a disconnect between market sentiment and the real economy.

"When it comes to financial conditions, it's just the sovereign that's benefiting from the more favorable perceptions of Spain," Spiro said.

"Borrowing costs for businesses and households remain punitive and show how the transmission mechanism is still impairing the European Central Bank's monetary policy," he added.

(Read More: 'Sense of Urgency' as ECB Rate Cut Talk Rises)

Norman Villamin, European CIO at private bank Coutts said a TARP like system was needed in order to by-pass the dysfunctional banks that are still not lending.

"Non-functioning banking systems are the issue, rather than an absence of liquidity. So for ECB action to be truly effective, we think it needs to include direct lending by either the ECB itself or some supra-national agency (e.g. the European Investment Bank), bypassing the dysfunctional banks," said Villamin.

"If European Union policymakers move decisively in the direction of a TARP-like program, this would finally provide the catalyst for attractively valued European equities to rally," he said.

—By CNBC.com's Jenny Cosgrave; Follow her on Twitter @jenny_cosgrave