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By Rebecca Clancy | Published Jul 09, 2012

ECB interest rates cut draws mixed reaction

Experts were divided on the effect of the European Central Bank’s (ECB) decision to cut its deposit rate last week, as Spanish bond yields hit danger levels after the bank’s announcement.

The bank said on July 5 that it was cutting its main refinancing interest rate by 0.25 percentage points to 0.75 per cent – its lowest ever level. The ECB also announced it was cutting its deposit rate by 0.25 percentage points to 0 per cent, in a move that should encourage the eurozone’s banks to lend money in order to earn a return on capital.

ECB president Mario Draghi said last week that the bank’s 22-member governing council had voted unanimously to cut the rates.

“We are now seeing a weakening of growth in the whole of the euro area, including countries that had not experienced it before,” Mr Draghi said in a press conference last week.

Nevertheless, Azad Zangana, European economist at Schroders, said the interest rate cuts would do little to help the flailing eurozone economy or crisis-hit members such as Spain.

“The cut in the ECB’s interest rates will be marginally beneficial for the eurozone economy but by no means removes the risk of recession in the near term nor resolves the sovereign debt crisis,” he said.

John Velis, head of capital markets research for Europe, the Middle East and Africa at Russell Investments, said he was surprised by the decision to cut the deposit rate, saying it misses the point of the crisis facing the eurozone.

“The problem in the eurozone is not that policy rates are too low, but rather [it is] a sovereign debt crisis in a monetary union that still lacks the centralised policy tools to deal with it,” he said.

However, Scott Thiel, BlackRock’s deputy chief investment officer for fundamental fixed income, said the cut to the deposit rate may have a greater impact than the cut to the main refinancing rate.

“Financial institutions will start to question the viability of keeping their cash in a safe haven that returns little or nothing,” he said.

He added that this would put downward pressure on yields of high-quality bonds with a short maturity, as well as on the euro.

Mr Thiel said the cut in the main rate was “more symbolic than meaningful” – a positive sign from the ECB that it supported EU leaders’ conclusions at their summit last month.

Leaders at the summit agreed a plan that will see EU bailout funds being injected directly into Spain’s banks.

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