Why This May Be the Week the ECB Cuts Rates

Mario Draghi, President of the European Central Bank
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Mario Draghi, President of the European Central Bank

Thursday's meeting of the European Central Bank's rate-setting committee could mark a key moment in the evolution of the euro zone debt crisis, as a growing number of economists predict that it will vote to cut interest rates again.

ECB President Mario Draghi has made several bold decisions in his first year in charge, notably the pledge to support struggling states through bond buying via Outright Monetary Transactions (OMTs), and an interest rate cut could be the next.

A cut would make the ECB's deposit rate, currently zero, negative – effectively charging companies to deposit money. While this could mean that banks put their money to work elsewhere, it could also mean that ordinary savers have less incentive to put money aside.

The headline refinancing rate is currently 0.75 percent, but at the moment this has less effect on short-term borrowing than the deposit rate because cheap ECB loans have already made borrowing money less expensive.

Most economists believe that the central bank will keep interest rates on hold this month – although an increasing number think that it will cut in the next three months, according to a poll by Thomson Reuters. The last time that the committee voted to cut rates, to their current historic low of 0.75 percent, was last July.

Since then, economic data for the euro zone has steadily worsened in the fourth quarter, suggesting that the recession in the single currency region is deepening, which could prompt the ECB to do whatever it can to promote growth. A cut to interest rates is traditionally viewed as a way to stimulate the economy. The central bank has recently cut its forecasts for growth in 2013, suggesting that it too is concerned about the smoke signals on the economy.

The rate-setting committee "briefly touched upon" the consequences of a negative deposit rate in its last meeting, according to Draghi.

Analysts at Morgan Stanley forecast that the central bank will cut the deposit rate and the refinancing rate by 0.25 point – but said this is not a "done deal" yet.

"The ECB might prefer to ponder the issue of the deposit rate cut somewhat longer in light of potential operational considerations as well as political concerns (notably public opinion in core countries such as Germany)," they argued.

As well as the key unemployment and growth figures, credit conditions in the region are also causing concern, despite the wave of cheap money. In November, private sector lending fell by 0.8 percent and there was no monthly change in the broad money supply, suggesting that banks are failing to pass on these cheap loans.

"We think the worsening collapse of credit – and an imminent crash in the growth rate of M3 – leaves the ECB no choice but to cut its repo rate in an effort to stimulate demand for credit," Carl Weinberg, chief economist at High Frequency Economics, argued.