The European Central Bank has to cut official interest rates by at least another percentage point to stop the real cost of borrowing for households and firms jumping in the summer as inflation plummets.
That’s the logical conclusion of comments in recent weeks made by ECB policymakers including Italy’s Mario Draghi and Germany’s Axel Weber, who are watching inflation-adjusted borrowing costs closely to gauge the impact of cuts in official interest rates on the real economy.
One key factor in the euro zone’s economic recovery will be the real cost of borrowing, the interest rate paid on credit after adjusting for inflation, or any loss of purchasing power.
Although there is a long academic debate about how to calculate this, several policymakers have done a simple equation of taking annual inflation (1.1 percent in January) away from the current benchmark interest rate (2.0 percent) to arrive at an estimate of the real cost of borrowing of just under 1 percent.
“In the euro area the real short-term rate is now below 1 per cent; if official rates had not been cut, it would have risen considerably because of the fall in inflation,” Draghi said in a speech in Milan on Feb. 21. “The Governing Council is keeping a close watch on the real cost of money.”