Chart view: Why another rate cut from the ECB will be meaningless

They all belong to the same currency union, but, clearly, everyone isn’t getting the same treatment.

The European Central Bank may have slashed its main short-term policy rate — the ‘refi’ rate — to a record low of 0.25% for the 18-nation eurozone, but corporate and household borrowers across the  currency bloc are not borrowing at the same ultra-low rates.

After the sovereign debt crisis, interest rates among different economies of the eurozone started diverging markedly as country-specific risks came to the fore.

A European Commission study of lending conditions in the eurozone, which used data from the ECB, found that borrowing costs for companies and households continue to remain high in some economies, despite an ultra-low refi rate.

The chart  (in link below) shows how borrowing costs are different based on the risk perceptions for different countries. Loans in crisis-struck Portugal and Cyprus, for instance, cost more than loans in Austria or Finland.

Click here to see the chart.

A recent Reuters report also notes that while the difference in borrowing costs between eurozone nations has narrowed, it remains fairly significant. For instance, in January, companies in Portugal paid 5.45 percent interest on new loans on average, while in Finland, companies paid just 2.07 percent.

What does that mean? It means that the “transmission mechanism”  — the process by which a low policy rate filters through the economy in the form of lower borrowings costs is broken. It’s a fact the ECB acknowledges.

No wonder, the ECB isn’t keen to keep cutting rates further (of course, the fact that the policy rate is already near zero is also pertinent).

The whole point of cutting rates is to encourage borrowing for investment and consumption. But if borrowers continue to borrow at relatively high cost, the effect of boosting investments/consumption is diluted/lost.

Cutting the interest rate further in such a situation in the hope of stimulating economic activity becomes kind of meaningless.

With deflation becoming a threat to the region, it’s time for the ECB to think of some new ways to goose the eurozone. But that seems unlikely for now.

[Image Credit]

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