The ECB Is Not Cutting Rates Fast Enough

The European Central Bank just doesn't get it. The Federal Reserve has driven the fed funds target to zero to 25 basis points. Short-term U.S. Treasury bill yields have on occasion dipped below zero. As this is written, the three-month T-bill yield is quoted at minus 5 basis points. And still there is demand.

What the ECB doesn't get is that sometimes the demand for money is inelastic to its price. Simply put, the low cost of money, i.e. interest rates, does not necessarily increase demand.

Seemingly still reluctant to appreciate the magnitude of the economic and financial tsunami, the ECB fiddles as Rome burns. On Thursday, the ECB announced that it would cut the interest rate it pays on money deposited with it and raise the rate it charges to borrow money from it.

Previously, it paid 50 basis points less than its refi target rate, now at 2.50%, and charged 50 basis points more for its emergency lending rate. Now the spread will be 100 basis points. But there is no sense of urgency. Today's measures will not be implemented until Jan. 21, more than a month from now.

Ostensibly, the move is to discourage banks from leaving excess deposits with the ECB. These deposits are similar to the excess reserves that banks are leaving with the Federal Reserve. The deposits at the ECB are running more than four times the long-term average, according to Bloomberg data. The hope is that this interest rate adjustment will encourage banks to take the money from the ECB deposits and lend it to households and businesses. Fat chance.

The reason why European banks, like U.S. banks, are not lending has a supply and demand component. The supply is being constrained by banks rebuilding their balance sheets. The demand is being constrained by risk-averse households, rising unemployment, a dramatic slowing of the economy and rising rates of unused industrial capacity, leaving businesses reluctant to borrow.

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Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.