Chart: Why a new rate cut is unlikely to stoke eurozone demand

The buzz is getting louder about another interest cut in the benchmark rate, the refinancing or refi rate, by the European Central Bank.

A central bank’s benchmark rates are supposed to influence the direction of lending rates across the economy. A rate cut by the central bank should typically lower lending rates of banks, which  should increase  demand for funds for investment and consumption.

That’s the theory anyway.

But that has not been the case in the 17-nation currency bloc.

Here’s a chart that shows credit demand in the face of already low interest rates

Demand for credit has remained sluggish since 2011, mainly because banks have been busy cleaning their books over that time.

Many banks in the eurozone continue to be wary of lending because they don’t want to exacerbate their level of bad debts. The funds available for lending have instead been parked in ‘safe haven’ bonds and other securities. While overall conditions have improved for financial markets, the perception of risk remains high.

Many businesses are also hesitant about investing because consumer demand remains subdued. Meanwhile, with unemployment levels running at record highs, consumers are opting to hold on to their wallets than than splurge.

All in all, low interest rates are doing little to juice economic activity in the eurozone. In addition, at such low rates, the central bank is rapidly reaching the limits of this monetary tool and will have to start using  other tools from its weapons kit.

Under these conditions, what good will another rate cut do? Your guess is as good as mine.

[Image Credit]


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