The European Central Bank is still dragging its feet, even as the euro zone sinks deeper into recession. Instead of continuing the sharp cuts to its refinancing rate – down 2.25 percentage points to 2% in three months – it stood pat Thursday. It needs to do more, and fast.
President Jean-Claude Trichet did soften his tone. While reiterating his view that zero interest rates aren't desirable, he notably added "at this stage." And one view is that ECB is heading toward a zero-rate policy on the sly.
The overnight interbank lending rate, known as Eonia, has actually fallen sharply to 1.2% from 2.1% in the past three weeks. But why say one thing and do another? Other central banks see no need for that. The Federal Reserve has got rates down to zero. The Bank of England lopped another half-point off its base lending rate to 1% Thursday. It hasn't ruled out further cuts.
The ECB faces similar economic challenges to other regions. There were unexpectedly steep declines in Spanish industrial production and German factory orders in December. BNP Paribas forecasts euro-zone GDP will fall 2.8% this year, with Germany, the biggest euro-zone economy, shrinking by 3.3%. Meanwhile, the ECB has not yet unblocked the banking system.
The ECB's worry about creating a liquidity trap looks like a red herring. Central Bank of Cyprus Governor Athanasios Orphanides has pointedly broken ranks with other ECB governors. Mr. Orphanides has warned of the danger of inaction should a central bank worry needlessly that it might run out of monetary policy ammunition if it reduces rates to zero. After all, the earlier such ammunition is used, the longer it has to work and the more likely it will have an effect.
Also, the ECB has hardly been shy of unorthodox policy responses. It was the first to broaden massively the collateral it would accept for its repurchasing activities and has increased the size of its balance sheet by a third. Mr. Trichet says other measures, such as buying sovereign debt or commercial paper to bypass the blocked banking system, are on the table. But he's doing nobody any favors in insisting pre-emptive cuts in interest rates remain a policy response the bank won't consider as the economic storm gathers.
