Page last updated at 15:58 GMT, Thursday, 15 January 2009

Will European rate cuts halt the downturn?

By Ben Shore
Europe business reporter, BBC News, Brussels

Jean-Claude Trichet, president of the European Central Bank and his deputy Lucas Papademos
It seems Mr Trichet suddenly changed his mind

There wasn't supposed to be a cut in Eurozone interest rates this January.

Jean Claude Trichet, president of the European Central Bank (ECB) had said there was "a limit" to how low rates could go after three successive cuts saw the main lending facility at 2.5%.

But that was all the way back in December.

It is a sign of just how bad the economic situation is that the rate has now fallen to just 2%.

Out of work

Going through the figures, one has the sense of finally being hit by a tidal wave that had seemed to linger off shore for months.

The recession is upon us, not just in terms of gross domestic product, but in much more tangible and depressing facts.

Eurozone industrial production is down 7.7% year on year - a record drop. Why make things when no one is buying?

The picture for unemployment is equally depressing. More than 12 million people in the Euro area are unemployed and the figure is rising dramatically.

The situation in Spain is truly horrendous; an unemployment rate of 13.4%, or three million people.

One of the few bodies doing well out of the financial crisis is the Spanish army, which has seen a huge increase in recruitment from people looking for something, anything, offering a steady income.

Falling prices?

And one final figure to throw in the pot.

European Central Bank
The eurozone is in deep trouble, and it seems to be getting worse

Inflation has come down to 1.6%. That is the lowest figure for more than two years.

In itself the number does not seem too bad, as the main objective of the ECB is to keep inflation at "below but close to" 2%.

But the direction of travel is alarming; the figure was at 4% in July.

Carsten Brezski, a senior economist at ING bank, insists the real fear now is deflation, the phenomenon where money becomes more valuable as prices drop.

That would be bad news for people with loans because they would, in effect, increase in value.

Little lending

The question now is whether today's cut will have any impact at all on the worsening economy, or more particularly whether it will persuade banks to lend more money. Almost everyone agrees that tightening credit conditions are a major factor in the downturn.

The answer is; yes, up to a point.

In October and November, the ECB's main interest rate came down by 1%, and it seems that banks in the eurozone passed on roughly half of that cut to their customers.

But just looking at rates will tell the whole story.

The question in Europe is what volumes of money are being lent, not simply the cost of borrowing.

On that score the figures reveal a grim picture.

The volume of new loans made available for house purchases were down about 40% for short-term flexible loans and by some 25% for longer term fixed-rate deals.

But interestingly, the amount of money being lent to businesses, one of the things European governments are most worried about, has dropped by about 10%, excluding bank over drafts.

Bad, but not, as yet, catastrophic.

Of course the figures are not yet available for December, and no one is expecting things to improve.

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