ECB Should Not Reduce Pandemic Rate, Sources Say

* The rate reduction is not on the agenda

* Limited impact seen on the economy

* Policy makers downplay the strength of the euro

FRANKFURT, Jan.29 (Reuters) – The European Central Bank is unlikely to lower its already record-high key rate as that would do little to revive the economy of the pandemic-stricken euro area, told Reuters five sources, downplaying concerns about a strong euro.

Traders scratched their heads this week when Dutch central bank governor Klaas Knot said the ECB “had leeway” to push its deposit facility rate, currently minus 0.5%, more below zero if necessary to stem a euro rally.

The sources said Knot raised the issue of the rate cut at the ECB policy meeting last week, but the discussion was “marginal” and not part of the ECB’s policy strategy, which is now focuses on buying cheap bonds and lending to banks.

“Even if you see a much larger appreciation, I wouldn’t say the only answer to that is the interest rate,” said one of the policymakers.

The sources noted that the ECB was now focused on keeping funding conditions stable, namely bond yields and bank lending rates, and said the exchange rate was a secondary issue.

The sources added that there were a number of reasons to oppose a rate cut: their limited impact on the real economy; the euro exchange rate is still within its historical range; and the limited possibility of making rates more negative before they start to do more harm than good.

A sixth source warned that could change if the euro, which has gained 14% against the dollar since March, continues to appreciate due to the continued monetary stimulus from the Federal Reserve.

An ECB spokesperson declined to comment.

ECB President Christine Lagarde last week reaffirmed her long-held position that no instrument was “off the table” and sources said a rate cut was still technically possible if the circumstances fundamentally changed.

The euro hit a two-year high against the US dollar at $ 1.2349 earlier this month, but has since weakened, along with eurozone economic data, and has now traded somewhat over $ 1.20.

On a trade-weighted basis, the euro has stagnated since the summer around an 11-year high.

TO CUT OR NOT TO CUT?

A rate cut, the theory is, would dampen financial flows to the euro, which helped fuel the recent surge.

And a weaker currency would make life easier for exporters, who compete on price with companies around the world.

Yet there are few other noticeable advantages and several disadvantages to pushing the deposit rate further into negative territory, which effectively increases the fees commercial banks pay to park their unused cash at the ECB overnight.

First, it wouldn’t do much to encourage more lending, which is currently constrained by banks’ fear that households and businesses affected by the pandemic will be unable to repay their loans, rather than high rates.

Second, it would hurt the banks and likely force the ECB to grant them more exemption from that same charge through its tiered pay system, effectively reversing part of the rate cut.

Third, if the ECB wanted to make liquidity even cheaper, it could do so more easily by lowering the rate on its multi-year loans to banks, which is currently -1% until June 2022 for lenders who do not cut their loans. loan portfolio. .

Fourth, the ECB sees its bond purchases and loans as its first port of call if it feels it needs more force to lift the eurozone economy out of deflation.

“There is no need to cut the rate now,” ECB politician and Latvian Governor Martins Kazaks told Reuters this week. “There are other instruments that are more appropriate in the current situation.” (Editing by Jon Boyle)