European Central Bank cuts interest

Responding
to a drop in euro zone inflation well below its target level and rising
unemployment, the ECB lowered its main rate by a quarter percentage point to a
record low 0.50 percent. ECB
President Mario Draghi, promising to provide as much liquidity as euro zone
banks need well into next year and to help smaller companies get access to
credit, also indicated that some policymakers had pushed for a bigger cut.

The
ECB was also "technically ready" to cut its deposit rate from the
current zero percent into negative territory, meaning it would start charging
banks for holding their money overnight.

Such
a move could encourage the banks to lend out money rather than hold it at the
ECB, though it would also probably have a big impact on banks' own operations and
major implications for funding and bond markets.                 

Draghi said the ECB could cope with these –
a departure from his previous statements." There are several unintended
consequences that may stem from this measure," he said of a negative
deposit rate. "We will address and cope with these consequences if we
decide to act. And we will again look at this with an open mind and we stand
ready to act if needed. Thursday's cut in the main rate had been widely
expected after Draghi said last month that the ECB stood ready to act, but few
economists expect it to make a decisive difference.

Acknowledging
that, the ECB said it would prime banks with as much liquidity as they need
until at least July 2014 and look at ways to boost lending to smaller
companies, which are the lifeblood of Europe's economies but have been starved
of credit in many countries.

SMALL COMPANIES, BIG PROBLEM

The
ECB wants to improve the transmission of its monetary policy so its low rates
reach all corners of the euro zone.

The
bloc's south is not benefiting to the same extent as the north from the
ultra-low rates. If they are lending at all, banks there are charging companies
and households more for loans than their peers in the north because of higher
funding costs and credit risks.

The
ECB has repeatedly voiced its concern about the impact this has on lending to
small- and medium-sized enterprises (SMEs), which have little alternative to
bank funding. The ECB wants to revive an asset class that has widely been blamed
for causing the financial crisis – asset-backed securities (ABS).

This
asset class allows banks to pass at least some of the credit risk on to other
investors as they try to boost their capital and liquidity buffers to adapt to
new regulatory standards – one reason for their reluctance to lend.

"The
Governing Council decided to start consultations with other European
institutions on initiatives to promote a functioning market for asset-backed
securities," Draghi said, adding that no decisions had been taken.

Berenberg
Bank's Holger Schmieding said that if other institutions, such as the European
Investment Bank, helped promote an ABS market for SME loans, the ECB could
eventually pave a way to some quantitative easing.

The
ECB could accept such packaged loans as collateral at its liquidity operations,
or even buy them outright, he said.

"If
so, this would extend the ECB's toolbox and could potentially open the way for
a little 'quantitative easing' by the ECB later on," Schmieding added.