The European Central Bank (ECB) has today announced a cut in it’s base rate of interest to 0.50%
This is nothing unexpected but does highlight a few interesting developments in the Eurozone. First things first, what is a base rate?
Base rate is a commonly used term, think of it as the base level from which savers receive interest and borrowers pay interest. The simple explanation is that savers get paid at a percentage below base rate, borrowers borrow at a percentage above base rate. In this was a central bank can either restrict or increase disposable income.
At least that is the theory. If inflation is a problem then put base rate up, people reduce spending and prices come down to encourage them to spend, and so on.
What Is Different Now?
The ECB set interest rates for the Eurozone. Which is a pretty diverse place at the moment.
Normally (and we say this through gritted teeth), when base rates fall then so does your currency because less people want to buy your currency as their return is less (think of them as savers), this is especially relevant to any business with any international element.
However, this has not happened. The Euro has strengthened against the Dollar, probably due to expectations that a cut in base rate by the ECB will see Eurozone productivity increase, and hence longer term gain (think of it as buying in while it is cheap).
Probably the key part of the ECB thinking in cutting base rate is to encourage business lending, however if Spain and Ireland are an example then already struggling banking systems may find this a big ask, experience say that easing credit in this scenario is very difficult.
We wait and see what will happen and whether a cut in ECB base rate has any influence over what the Bank of England decide in a fortnights time.
If you have any comments about this article then please add them above or contact us via the website here.