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What Europe's bold interest rate cuts mean for SA

Lisa Steyn

The European Central Bank announced that it cut interest rates by 10 basis points to a record low of 0.05%.

The European Central Bank announced it will cut interest rates to relieve its flailing regional economy by 10 base points, a record low of 0.05%. (AFP)

Speaking at a press conference in Frankfurt on Thursday afternoon, president of the European Central Bank (ECB) Mario Draghi said its governing council decided to lower the interest rate on the main re-financing operations of the Eurosystem by 10 basis points to 0.05%, and the rate on the marginal lending facility by 10 basis points to 0.30%. 

The rate on the deposit facility was lowered by 10 basis points to -0.20%.

“In addition, the governing council decided to start purchasing non-financial private sector assets. The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP),” Draghi said. 

“This reflects the role of the ABS market in facilitating new credit flows to the economy.” An asset-backed security, according to Investopedia, is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities.

“In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs [Monetary Financial Institutions] domiciled in the euro area under a new covered bond purchase programme [CBPP3],” Draghi said. 

Interventions under these programmes will start in October 2014 and the detailed structures of these programmes will be announced after the Governing Council meeting of October 2, he added. 

Effects on SA
Chris Hart, chief economist at Investment Solutions said: “These policy decisions are of such significant economic areas that their policy decisions are not confined to their specific jurisdiction and it feedbacks into South Africa.” One of the repercussions is erratic capital flows, Hart said.

“This leads to volatility, which leads to distorted prices and feeds back into the economy, so things such as inflation and growth could be affected.”

The developments also likely mean a stronger rand against the euro as the ECB is “debasing their currency,” Hart said. Euro dropped to its lowest level against the United States dollar in 14 months upon the news from the ECB. 

“If the ECB gets it right and gets economic growth going, that’s good for us. They are the biggest trading partner from an investment point of view,” said Hart. “And if the European economy is growing faster, that counterbalances some of the negative news coming out of the US.” 

But stimulus, Hart said, was likely not an ultimate solution. “The fed and the ECB are both kicking the can down the road they are not dealing with the problem at its core,” he said. 

Pressure for the ECB to make a move had been mounting and exasperated recently dismal economic growth numbers coming out of various countries in the region. Draghi said the bank had cut its growth forecasts for 2014 and 2015 and expected 0.9% growth this year and 1.6% in the next.

US interest rates
At economic symposium held by the Federal Reserve Bank of Kansas City two weeks ago all eyes were on Federal Reserve chairperson, Janet Yellen for indications as to whether the US would hike interest rates soon. 

The US continues on a slow and steady recovery with inflation coming into the lower end of the Federal Reserve’s target band, but Yellen made clear that deflation was still a risk as wage inflation remained flat. 

However, Draghi indicated fresh monetary stimulus may well be on the cards for the flailing Euro area. He said Thursday’s decisions will add to the range of monetary policy measures taken over recent months. “In particular, they will support our forward guidance on the key ECB interest rates and reflect the fact that there are significant and increasing differences in the monetary policy cycle between major advanced economies,” he said. 

“They will further enhance the functioning of the monetary policy transmission mechanism and support the provision of credit to the broad economy.” The Bank of England on Thursday also announced its monetary policy committee decision to keep the Bank Rate at 0.5% as well as to maintain the stock of purchased assets financed by the issuance of central bank reserves at £375-billion.


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