ECB Cuts Interest Rates-VRK100-10Nov2011

ECB Cuts Interest Rates

Rama Krishna Vadlamudi, HYDERABAD   10 November 2011
www.ramakrishnavadlamudi.blogspot.com

On 3 November 2011, the European Central Bank, headquartered in Frankfurt, decreased the key interest rate in the eurozone to 1.25 per cent from 1.50 per cent effective 9 November 2011. This is the key rate through which ECB provides the bulk of the liquidity to the banking system in the eurozone.

This is the first policy action taken by Mr Mario Draghi immediately after taking over as ECB president. He had taken over the duties as president of the ECB on 1 November 2011. He replaces Jean-Claude Trichet who served from 1 November 2003 till 31 October 2011.

Update on Eurozone Debt Crisis:

Italian Government’s cost of borrowing has gone up to more than seven per cent as investors are afraid that Italy will be next victim of the eurozone debt crisis. The yield on 10-year Italian government bond has gone up to seven per cent, this is the highest since the formation of eurozone in 1999.

The economic and financial crisis in the eurozone is fast turning into a political crisis with the Greek government in trouble and the Italy’s prime minister, Silvio Berlusconi, saying he would resign after the financial reforms are passed. Talks are going on in Greece to form the next government as the current prime minister George Papandreou is set to resign.

This brief write-up discusses the key policy interest rates of European Central Bank (ECB). The eurozone is now facing a debt crisis after the global financial crisis of 2008 with several EU nations, like, Greece, Ireland, Portugal and Spain facing economic chaos due to enormous public debt, banking crisis and possible economic recession. Some defaults are expected in the eurozone.

Key interest rates of the ECB:

There are three important rates set by the ECB. The most important of them is the refinancing rate of the Main Refinancing Operations.

1. Refinancing Rate: This refinancing rate is considered as the key policy rate of the ECB. Main Refinancing Operation is a regular open market operation conducted by the national central banks (NCBs). Under the MRO, the NCBs provide the majority of the liquidity to the banking system in the euro area (or eurozone). MRO is conducted on a weekly basis and normally has a maturity of one week. The refinancing rate of 1.00%, effective from May 13, 2009 till April 12, 2011, was the lowest in the ECB’s 10-year history. The present rate is 1.25 per cent effective from 9 November 2011.

MAIN REFINANCING OPERATIONS (MRO)
w.e.f.	Refinancing Rate (key ECB policy rate)	Action
9-Nov-11	1.25% fixed	down by 25 bp
13-Jul-11	1.50% fixed	up by 25 bp
13-Apr-11	1.25% fixed	up by 25 bp
13-May-09	1.00% fixed	down by 25 bp
8-Apr-09	1.25% fixed	down by 25 bp
11-Mar-09	1.50% fixed	down by 50 bp
21-Jan-09	2.00% fixed	down by 50 bp
10-Dec-08	2.50% fixed	down by 75 bp
12-Nov-08	3.25% fixed	down by 50 bp
15-Oct-08	3.75% fixed	down by 50 bp
9-Jul-08	4.25% variable	up by 25 bp

2. Deposit Facility: It enables commercial banks in the euro area to park their surplus funds with their respective national central banks (NCBs) at this rate. It is an overnight facility. The present rate is 0.50% from 9 November 2011. (It is similar to Reserve Bank of India’s Reverse Repo rate under its Liquidity Adjustment Facility.)

3. Marginal Lending Facility: It is an overnight facility by which liquidity is offered to the financial sector from the eurosystem. It is a standing facility through which counterparties receive credit from a national central bank at a pre-specified interest rate against eligible assets/securities.  The  present  rate  is 2.00 per cent,  effective  from 9 November 2011. (It is similar to RBI’s Repo rate under LAF.)

Rate Corridor: The interest rates on marginal lending facility and deposit facility normally provide a ceiling and a floor for the overnight market interest rates. Overnight market rates are expected to move within this corridor.

OVERNIGHT FACILITIES
Deposit Facility			Marginal Lending Facility
w.e.f	Rate	Action	w.e.f	Rate	Action
9-Nov-11	0.50%	down by 25 bp	9-Nov-11	2.00%	down by 25 bp
13-Jul-11	0.75%	up by 25 bp	13-Jul-11	2.25%	up by 25 bp
13-Apr-11	0.50%	up by 25 bp	13-Apr-11	2.00%	up by 25 bp
			13-May-09	1.75%	down by 50 bp
8-Apr-09	0.25%	down by 25 bp	8-Apr-09	2.25%	down by 25 bp
11-Mar-09	0.50%	down by 50 bp	11-Mar-09	2.50%	down by 50 bp
21-Jan-09	1.00%	down by 100 bp	21-Jan-09	3.00%	down by 75 bp
10-Dec-08	2.00%	down by 75 bp
12-Nov-08	2.75%	down by 50 bp	12-Nov-08	3.75%	down by 50 bp
9-Oct-08	3.25%	up by 50 bp	9-Oct-08	4.25%	down by 50 bp
			8-Oct-08	4.75%	down by 50 bp
			9-Jul-08	5.25%	up by 25 bp

   Data is as on 9 November 2011                             Data Source:  ECB

Definitions:

European Central Bank (ECB):

The ECB sets the interest rates and is responsible for the single monetary policy of the euro area. It is headquartered in Frankfurt, Germany.

Euro area (or eurozone):

Those EU member states that have adopted the ‘euro’ as their single currency are part of the euro area. There are now 17 European countries which are members of the eurozone, with a common currency, the euro.

Eurosystem:

Eurosystem is the central banking system of the euro area. The ECB and the national central banks of the European Union (EU) member states that have adopted the ‘euro’ as their common currency are part of the eurosystem.

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Note on author: Author is an investment analyst and writer. The views are personal and this is written only for information purpose. The author has a vested interest in the stock markets. Readers are advised to consult their certified financial adviser before taking any investment decisions.

Author’s articles on financial articles can be accessed at:

www.ramakrishnavadlamudi.blogspot.com