European Rescue Mission: Will ECB Cut Interest Rates Even Lower?

European Central Bank President Mario Draghi has announced the possibility of reduced interest rates for European banks, only a week after the central bank brought them to a record low. Markets responded, with the euro falling around a half percent against the dollar to $1.3063. European stocks were down slightly as well.

The ECB’s actions were prompted by additional news that a recovery by the year’s end may not happen, as member banks are still struggling to lend to small- and medium-sized businesses, which are the main driver of EU growth. Draghi also said that he had begun working with the EU’s executive commission to create a tradable class of securities based on loans to businesses, a move thought to free up more capital for lending.

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However, Draghi noted that lowered interest rates will not be enough, saying that “to mitigate the inevitable recessionary effects of fiscal consolidation, the composition of such measures must favor the reduction of current public spending and of taxes, particularly in a context such as in Europe where taxation is already high by international standards.”

Member countries such as France are already facing internal struggles crafting policy beneficial to both growth and deficit reduction. Earlier this year, French president, François Hollande vowed to levy a 75 percent tax rate on France’s top earners, a measure which was later defeated by the French courts. Hollande has recently changed this effort to target employers, a move many fear will discourage investment. Domestic policy at odds with the central bank creates a perilous scenario as the EU searches for growth.

The lowered rates also come at a time when EU inflation has slowed to only a 1.2 percent increase in the price of consumer goods for the month of April, down from 1.7 percent in March. These figures are seen as giving leeway to the ECB in maintaining high amounts of cash for banks.

With news of low inflation at hand, the ECB also announced plans to continue providing unlimited liquidity to banks in hopes that such a practice will encourage lending activity. The bank has followed the lead of U.S. Federal Reserve Chairman Ben Bernanke, who has also worked to keep interest rates at historic lows, and who implemented a third round of bond buybacks known as ‘quantitative easing’.

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Central banks are making efforts of their own in order to spur growth, but unless effective policy making can accompany it, their ability to turn around the macro-economic picture in their respective countries will remain difficult.

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