ECB ready to cut rates, push banks to lend

Frankfurt - The European Central Bank (ECB) is poised to impose negative interest rates on its overnight depositors, seeking to cajole banks into lending instead and to prevent the euro zone falling into Japan-like deflation.

At its meeting on Thursday, ECB policymakers may also launch a loan programme for banks with strings attached to make sure the money actually gets out into the euro zone economy.

It will be the first of the "Big Four" central banks - ECB, Bank of England, Bank of Japan and US Federal Reserve - to go the negative interest rate route, essentially charging banks to deposit with it.

Even though the risks are limited of the euro zone entering a spiral of falling prices, slowing growth and consumption, the ECB is increasingly concerned that persistently low inflation and weak bank lending could derail the recovery.

The economy grew just 0.2% in the first quarter, and euro zone annual inflation unexpectedly slowed to 0.5% in May, official data showed this week, piling additional pressure on the central bank to step in.

"Consensus for action is high so there is a ... risk the ECB under-delivers relative to the market's lofty expectations," said Andrew Bosomworth, a senior portfolio manager at bond fund Pimco in Munich.

Since ECB President Mario Draghi last month signalled the Governing Council's readiness to act in June, policymakers have come out in force to discuss the ECB's toolbox, feeding expectations that a broader stimulus package is in the making.

This is likely to consist of a cut in interest rates, which would push the deposit rate for the first time into negative territory and the offer of longer-term loans linked to further lending. Large-scale asset purchases remain a distant prospect.

Cutting the deposit rate below zero would see the ECB charge banks for parking their excess money at the central bank - a step it hopes will prompt them to lend out the money instead.

Economists in a Reuters poll expected the ECB to cut its main refinancing rate to 0.10 percent from 0.25% and the deposit rate to -0.10% from zero, on top of launching a refinancing operation aimed at funding firms.

They expect bank lending to rise as a result of such measures, but foresee only a marginal impact on the euro.

The euro has fallen about 4 US-cents against the dollar since the ECB's May meeting, hitting $1.3586 last Thursday.