Weber warns on rate cut

Bloomberg

"I’m critical of reducing the main refinancing rate below 1 percent" because there would be practically no incentive for banks to lend to each other, Weber said in a speech in Hamburg yesterday. "Therefore, the risk exists that the private interbank market would become completely paralyzed."

Interbank lending
While ECB President Jean-Claude Trichet has signaled the bank is likely to lower the benchmark rate to 1 percent from 1.25 percent next month, he’s ruled out cutting the deposit rate further from 0.25 percent. Narrowing the gap between those two rates reduces the incentive for banks to lend to each other.

They can borrow cash from the ECB and park excess funds with the central bank overnight. The minimal cost may be preferable to the risk of lending to another institution. Still, Austria’s Ewald Nowotny said last week the debate on whether to take the key rate below 1 percent is still open.

Greece’s George Provopoulos and Athanasios Orphanides of Greek Cyprus have both indicated they may support further rate reductions. Weber said taking the benchmark below 1 percent could "lead to additional distortions on the already fragile markets for short-term funding."