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Analysis
ECB’s interest rate cut is a done deal

ECB’s interest rate cut is a done deal

Big question is whether this heals or opens European divisions 

by David Marsh

Wed 21 May 2014

The European Central Bank’s (ECB) well-trailed plan to cut its main lending rate to zero and move to negative interest rates for deposits next month is a done deal. The big question is how much this matters – and whether the all-but-agreed step will open up further divergences across the continent rather than healing them.

Jens Weidmann, the president of the German Bundesbank, made clear last week in Berlin that Mario Draghi, the ECB president, faces a skirmish with the German central bank over the plan – which raises the risk of upsetting German savers and stoking up further asset price rises in Germany in areas like the housing market. 

Whether or not the Bundesbank submits quietly, or makes public its considerable objections, will be of interest from a political point of view, and to future economic historians. But it will not have an impact on whether the decision is implemented.

The Bundesbank is less critical about expected credit assistance for companies as part of targeted ECB measures to get loans flowing again to the small- and medium-sized business sector.

Of greater relevance are signs of renewed Bundesbank implacability over possible fresh credit measures directly to help euro area members still threatened by insolvency.

Disappointing data for European first quarter growth showed that Europe’s vaunted recovery is still proceeding dangerously slowly. Germany grew at a relatively robust 0.8% from the previous quarter, the same as Britain, which is not a member of the single currency bloc. But the French economy stagnated, and Italy’s declined 0.1%. Other economies returned to shrinking, too, while inflation is 0.7%, less than half the ECB’s target of close to 2%.

If Draghi and the rest of the 24-person ECB governing council fail to act next month, after so many indications and half-promises of further unconventional monetary action, the ECB president would face a disastrous loss of face. Helping him, central bankers have overcome initial worries that negative deposit rates at the ECB could spark banking software glitches similar to those feared under the ‘2000 meltdown’ nervousness at the start of the new millennium.

Last week Weidmann went further than before in saying that the ECB’s unitary monetary policies led to interest rates that were either too high or too low for individual euro countries. He scotched any idea that the euro crisis was over, saying, ‘We are around half-time.’

And he launched strong criticism of French governmental shortcomings in bringing down budget deficits, saying France was ‘at the limit’ of the performance allowed under tougher rules on macroeconomic surveillance.

Fresh indications of the unpopularity of budgetary cuts across Europe are in store. A major backlash is expected against mainstream pro-European parties in the European parliament elections across the EU’s member states.

Economic reforms across Europe have been disastrous for political support, but not effective enough to spur growth or bring down debt levels. Europe needs further centralisation in key areas to make monetary union work, but anti-European antipathy deprives governments of the levers to drive such measures through.

The only nations that wish to give up sovereignty over matters like public spending are those (like the Germans) who are quietly confident that they would actually be running the show. Precisely for this reason, the other countries (most importantly, France) do not want it.

Against this unpropitious background, news surfaced last week of another rearguard action by Weidmann, in November 2011, six months after he became Bundesbank president after previously working as Chancellor Angela Merkel’s economic adviser.

On the eve of the G20 summit in Cannes on the French Riviera, Weidmann fought off a plan to salvage euro members launched by the US and French governments to use stocks of Special Drawing Rights (SDRs), the International Monetary Fund’s composite currency unit. As revealed in an investigation by the Financial Times, Weidmann headed off the plan, on the grounds that SDRs are part of the Bundesbank’s reserves and cannot be lent out to governments without the central bank’s explicit approval.

The Bundesbank’s history is littered with cases where it has clashed with German chancellors over using the central bank’s reserves for political purposes – and where the politicians have normally finished on the losing side.

A landmark Bundesbank $2bn loan to Italy in 1974 backed by Italy’s gold reserves was secured only because Chancellor Helmut Schmidt managed to persuade his friend, then Bundesbank president Karl Kasen, to bypass the central bank’s council on the matter.

Other attempts by Schmidt to use the Bundesbank’s reserves for bilateral loans to Poland, the Soviet Union and Britain all foundered on Bundesbank hostility. Karl Otto Pöhl, a close aide to Schmidt who later became Bundesbank president, spoke of the government’s ‘helplessness’ in the face of Bundesbank opposition.

The Bundesbank torpedoed plans for reserve-pooling in 1979 to set up a European Monetary Fund as part of the European Monetary System, the forerunner of the euro area. And, more recently, in May 1997, the Bundesbank again prevailed, this time over Theo Waigel, the finance minister, over a plan to revalue the Bundesbank’s gold reserves to enable the Germans unequivocally to fulfil the convergence criteria for monetary union before it started in 1999.

High debt levels across the euro area will almost certainly bring back the subject of debt rescheduling across Europe – and the Bundesbank, representing Europe’s largest creditor, will be a major player. The evidence from Weidmann, both last week in Berlin and in November 2011 over the imbroglio in Cannes, is that he will put up a fight.

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