ECB Reduces Interest Rate and Euro Strengthens

Posted May 07, 2009

The ECB cut the interest rate to 1 percent which is a record low. The US issues the bank stress tests reports after measured release of information all week to condition markets. The Columbian peso continues to strengthen against the US dollar.


The European Central Bank announced two new measures on Thursday, 7-May-2009, intended to step up the battle against the recession.  The first action taken was a reduction in the benchmark interest rate by 25 basis points to 1 percent.  The second strategy involves implementing a tepid policy of quantitative easing that includes the ECB buying 60 billion euro of covered bonds.

The 1 percent interest rate is a record low for the ECB.  The reduction had been predicted and met investor expectations.  The ECB is experiencing some divisiveness as to the best steps to take for assisting the easing of the recession.  Germany wants the ECB to stay out of the purchase of debt at the government and corporate levels and to agree that 1 percent is now the interest floor.  Other members disagree on both counts.

The euro strengthened against the US dollar despite the disagreements because right now any action is often interpreted as a sign of strength.  The euro rose to $1.3356 against the US dollar.  It also rose against the yen to 131.10 yen.  Some analysts are saying the ECB plan to buy bonds does not contain the level of aggressiveness needed, while others are more optimistic.  The optimists are saying the action is overdue and the amount is significant enough to have an impact on the Euro-Zone economy.

The real issue causing disagreement and concern is the fact that the debt purchases will represent the ECB entering the private credit market.  That opens the balance sheets of central banks in the Euro-Zone to additional risk which they can ill-afford right now.

The Bank of England also made an announcement today which equated to saying additional quantitative easing is in the works.  The Bank has plans to spend 50 billion pounds to purchase additional assets in the form of government and business bonds (like the ECB).  The money being used was printed just to ease the recession which makes a cautious investor wonder what the impact on inflation will be in the next couple of years.

The UK pound weakened to $1.5018 against the US dollar.  It also fell against the euro to 89.26 pence per euro.

The US stress tests were finally released and the news impacted the stock markets more than the currency markets.  This is largely due to the fact the news had already been leaked by the government and absorbed by the markets.  In effect, 10 banks out of 19 need additional capital and they have been making plans on how to raise it.  The release of the stress tests and the slow supply of information over the last week were designed to prevent an over-reaction in the global markets.  In total, the banks will need approximately $74 billion in additional capital to cover anticipated losses in the credit card, loan, and mortgage sectors.

Mexico’s peso has been through some ups and downs this week due to the recession and the flu outbreak.  The peso fell against the US dollar to 13.1915 pesos per US dollar after a three day gain. 

The Columbian peso, on the other hand, continued its strengthening against the US dollar to 2,208.63 pesos per dollar.  As crude oil prices rise, the peso will rise also since oil is the country’s primary export.

The recession really does seem to be easing, but there are plenty of cautions being issued at the same time.  The stress tests have been carefully engineered to prevent market panic.  Unemployment in many countries, including the US and Australia, is still increasing, but at a slower rate.  Retailers are still struggling.  Plants are still shutting down for weeks at a time. 

The bottom line…it will take one to three years for many countries to recover from the worse recession seen since 1929.