As expected, the European Central Bank cut its refinancing rate by 25 basis points to a record low of 0.5% on May 2. The decision itself was little more than symbolic, due to its limited impact on credit transmission channels and actual borrowing costs, which vary widely across the region. It remains, for example, far more expensive for small and medium-sized businesses in Spain and Italy to obtain loans than in Germany and the Netherlands. The euro depreciated on the news, nonetheless, as it was accompanied by suggestions of a possible future shift to negative deposit rates (currently zero). Such a move matters as it would act as a collective tax on banks and might trigger sustained downward pressure on the currency through lower net capital inflows. Denmark and Switzerland (covered on pages 19 and 25, respectively) are two countries in Europe that charge banks a modest fee to park excess money with their central banks. In each case, their currencies have weakened from prior levels and growth, while sluggish, is positive. Yet critics warn that a similar tactic to revive output might not work for the euro zone, especially in a climate of extreme risk aversion. In addition, it could unintentionally hurt bank profitability at a time of capital shortages. Debate on the subject is likely to intensify as the recession in the region bites. The German-led austerity drive is losing support and the euro is vulnerable to bouts of volatility.
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