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Don’t Rule Out a Rate Cut from the European Central Bank

Financial markets, which are focused on what measures the European Central Bank will unveil this week to end the euro zone debt crisis, may be overlooking the potential for an interest rate cut at this week’s central bank meeting.

Euro coin in front of the giant symbol of the Euro outside the headquarters of the European Central Bank.
Thomas Lohnes | AFP | Getty Images
Euro coin in front of the giant symbol of the Euro outside the headquarters of the European Central Bank.

The ECB is widely expected to provide details at a meeting on Thursday about its plans to buy the government bonds of troubled euro zone states such as Spain, which saw its borrowing costs hit unsustainable levels just a couple of months ago.

Indeed, the meeting has become a highly-anticipated event after ECB President Mario Draghi pledged in late July to do whatever it takes to save the euro.

While attention is focused on the central bank’s bond-buying plans, investors should also not rule out a cut in the ECB’s key refinancing rate of 0.75 percent to show that it is determined to restore confidence in the battered single-currency zone, some analysts say.

“The markets aren’t banking on an interest rate cut but we wrote to clients last week and said a quarter of a percent rate cut is very possible this Thursday,” Thomas Murphy, Managing Partner at Family Office Research and Management, an independent investment advisory group based in Sydney, told CNBC Asia’s Squawk Boxon Monday.

“I think it (a rate cut) is possible because it would reinforce the quantitative easing that is also likely to be announced and remind markets that they (the ECB) are very serious,” he added.

A poll taken by Reuters last week showed that economists are split over whether the ECB would cut its benchmark interest rate this week, with most analysts expecting a rate reduction in October.

There are some signs, however, that markets are pricing in an increased chance of a cut in euro zone borrowing rates.

Three-month Euribor bank-to-bank lending rates fell to an all-time low on Friday of 0.278 percent – a sign that money markets are increasingly expecting an interest rate cut as soon as this week to help contain the euro zone crisis.

“Our economists expect the ECB to announce the details of a bond purchase program along with a more flexible collateral framework and a 25 basis point cut in the refi rate,” analysts at Barclays said in a research note.

Murphy at Family Office Research said that while the impact of any rate reduction was likely to be limited, the importance of such a move was more psychological.

Replying to a question about whether a rate cut would have any value, Murphy said: “Very little but it would be a symbolic move.”

- By CNBC's Dhara Ranasinghe

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