ECB prepares to launch fresh tools to battle low inflation
Mario Draghi to unveil package of measures next week to stimulate growth and fight threat of deflation
10:42AM BST 31 May 2014
The European Central Bank is preparing to take monetary policy into uncharted territory this week as it fights to prevent the 18-nation bloc from being sucked into a Japanese-style deflationary trap.
Mario Draghi, the president of Europe's central bank, is expected to unveil a package of measures designed to boost eurozone lending and stimulate growth, including reducing one of its key interest rates to below zero.
Analysts expect the ECB to introduce a negative deposit rate, meaning the central bank would charge lenders to hold money with it overnight. Such a measure has never been introduced by a major central bank, although Sweden and Denmark have set negative rates on reserves.
At the peak in 2012, nervous lenders parked a record €827bn (£672.7bn) overnight at the ECB, preferring to deposit new cash back with the central bank in order to guarantee safety. However, current data show that just €33.23bn was parked at the ECB overnight on Thursday.
The ECB is also expected to cut its main interest rate to 0.15pc, from 0.25pc. “We are ready to act,” Vitor Constancio, the ECB's vice president, said on Friday. “We are not complacent about the risks from a protracted period of low inflation.”
Policymakers have been preparing the ground for the ECB's package of new measures this week. In a speech in Portugal, Mr Draghi said it was the central bank's "responsibility" to be alert to the risks of low or negative inflation.
Eurozone inflation stood at just 0.7pc in April and is expected to remain at the same level in May.
"What we need to be particularly watchful for at the moment is, in my view, the potential for a negative spiral to take hold between low inflation, falling inflation expectations and credit, in particular in stressed countries," he said.
Deflation poses a threat to economies because if prices are falling people put off spending in anticipation of further falls. Retailers are forced to slash prices, which leads to declining profits, lower wages and people struggling to meet loan repayments because of falling salaries.
Eurozone banks are operationally ready for any move to introduce a negative deposit rate, according to reports. Reuters said banks in Germany, Austria, Ireland, Portugal and Slovakia were all ready to deal with negative cash flows from money on deposit.
The Bank of England also considered introducing negative interest rates at the height of the eurozone debt crisis. However, Martin Weale, an external member of the Bank of England's rate-setting committee, said last year that introducing negative rates in the UK would have signalled "a change in the nature of money as we know it".
He warned that companies could have started stashing money in secure warehouses instead of at the Bank of England if policymakers had made that move.
While the ECB is not expected to launch a full-scale quantitative easing programme at next Thursday's meeting, Mr Draghi reiterated that asset purchases remained an option. He said a destabilising of inflation expectations "would be the context for a broad-based asset purchase programme".
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