Get ready for record low interest rates in Europe as ECB ready to push boundaries of crisis role

A Reuters survey of 73 analysts showed a 60-percent chance the ECB will cut rates by 25 basis points to a record low of 1.0 percent — a floor it previously reached during the financial crisis in 2009. It cut rates by a similar amount in November.

New ECB President Mario Draghi reinforced expectations for a rate cut last week when he said the bank had a responsibility to ensure inflation did not undershoot its target of just below 2 percent, not just to stop it exceeding it.

Markets have taken it to heart. Three-month Euribor futures — one of the main gauges of market expectations — point to rates being be cut this month and then even further.

The case for a cut is supported by the euro zone economy teetering on the brink of recession. With the ECB increasingly concerned about falling consumer prices, further cuts may be in the offing even if the ECB has never cut rates below 1 percent before — not even after the collapse of Lehman.

Draghi made his comments a day after the world’s major central banks took emergency joint action to provide cheaper dollar funding for starved European banks.

This was the latest in a slew of actions aimed at propping up European banks, which are struggling with the fallout from the debt crisis, such as higher capital requirements and rising tension in the interbank money market.

Banks are increasingly turning to the ECB and the recent jump in overnight deposits at the ECB has highlighted the freeze in interbank lending markets.

Sources have told Reuters that the ECB is looking at extending the term of loans it offers banks to 2 or even 3 years to try to prevent the euro zone crisis precipitating a credit crunch that chokes the bloc’s economy.

One Size Fits Italy

Under ECB president Jean-Claude Trichet, ECB actions were best described as “One Size Fits Germany and France”. Under Draghi, ECB policy has morphed into “One Size Fits Italy”.

Central banks say and do what they want when they want. Eurozone inflation remains at 3 percent, for 3 consecutive months. So where did this concern for falling prices come from?

It certainly did not come from Eurozone price data. Rather it came from the desire of Draghi to help Italian bonds. That also explains Draghi’s comments to the European Parliament last week, that the ECB could take stronger action to fight the crisis if European leaders agree on tighter budget controls.

Tighter budget controls will not be realistic of course, but the illusion will give Draghi the cover he wants to buy more Italian bonds.

The can-kicking exercise continues. So does the ticking of the clock before the market once and for all decides it has enough of proposals that do nothing.

Mike “Mish” Shedlock
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