Rama Krishna Vadlamudi HYDERABAD

April 08, 2011 *

On April 7, 2011, the European Central Bank, headquartered in

Frankfurt, raised the key interest rates in the Eurozone to 1.25 per
cent from 1.00 per cent effective April 13, 2011. This is the key rate
through which ECB provides the bulk of the liquidity to the banking
system in the Eurozone. The key rate, officially called the Refinancing
Rate, was last revised in May 2009. The rate hike was signaled by
Jean-Claude Trichet, ECB President, last month itself and hence the
rate hike did not surprise the markets.
* This is the third revision of the original document dated September 21, 2009.
 Rama Krishna Vadlamudi, HYDERABAD April 8, 2011
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com

Background:

Following the global financial crisis that threatened to collapse the

global economy, key policy interest rates were kept artificially lower
by several central banks, like the ECB, the US Federal Reserve, the
Bank of Japan, and the Bank of England in the developed world, with
a view to giving a big boost to their flagging economies. Now, it
seems to be the time to reverse these low-interest rate regimes. The
ECB says it is doing a balancing act to curb inflationary threats in
Eurozone. The ECB is the first central bank in the developed world to
raise the interest rates. The ECB also raised its overnight deposit rate
to 0.5 per cent and its marginal lending rate to 2.0 per cent effective
April 13, 2011.

The latest rate increase may not be relished by countries, like,

Greece, Portugal and Ireland, because they have been depending on
massive bail-out packages being doled out by ECB to rescue these
countries from the sovereign debt crisis they are facing. The
economies of Greece, Portugal, Spain and Ireland have become
uncompetitive and they are facing other problems of huge public
debt, high unemployment rates and massive public unrest.

The bigger question now is when will the US Fed and Bank of
England start raising their interest rates. With the ECB firing the first
salvo, the times are very interesting for the currency markets.

In another development, Estonia has become 17th member of the

Eurozone, adopting euro as its currency from January 1, 2011.

This article discusses the key policy interest rates of European

Central Bank (ECB). It also throws light on the intricacies of
Eurozone, Eurosystem and such other terms connected with the
European Union and its economy. The Eurozone is now facing some
sort of a crisis after the global financial crisis of 2008 with several EU
nations, like, Greece, Ireland, Portugal and Spain facing economic
chaos due to enormous public debt and bankruptcy.

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 Rama Krishna Vadlamudi, HYDERABAD April 8, 2011
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com
European Central Bank (ECB):

The European Central Bank was established on June 1, 1998. The ECB sets the interest rates
and is responsible for the single monetary policy of the euro area. It is headquartered in Frankfurt,
Germany. It is part of the eurosystem.

Eurosystem:

Eurosystem is the central banking system of the euro area. The ECB and the national central
banks of the European Union (EU) member states that have adopted the ‘euro’ as their common
currency are part of the eurosystem.

Euro area (or Eurozone):

Those EU member states that have adopted the ‘euro’ as their single currency are part of the
euro area. A single monetary policy for the euro area is conducted by the ECB under the
responsibility of the Governing Council of the ECB. It is informally known as Eurozone, while the
official name is euro area. The ‘euro’ was launched on 1 January 1999 on foreign exchange
markets, and euro currencies replaced national currencies on 1 January 2002.

There are now 17 European countries which are members of the eurozone, with a common
currency, the euro, and a single interest rate set by the European Central Bank (ECB). Estonia is
the seventeenth country to adopt ‘euro’ as its common currency with effect from January 1, 2011.
The list of these 17 EU member countries that have adopted ‘euro’ as their single currency are
given in the annexure on page four. They make up of around three-fourths of EU’s GDP. The
following graphic shows 15 countries that adopted ‘euro’ before 2009.

Note: The micro-states of Monaco, San Marino and Vatican City also use the euro, on the basis of a formal arrangement
with the European Union. Andorra, Montenegro and Kosovo likewise use the euro, but without a formal arrangement.

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 Rama Krishna Vadlamudi, HYDERABAD April 8, 2011
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com

Key interest rates of the ECB: There are three important rates set by the ECB. The
most important of them is the refinancing rate of the Main Refinancing Operations (MRO).

1. Refinancing Rate: This refinancing rate is considered as the key policy rate of the ECB. Main
Refinancing Operation is a regular open market operation conducted by the national central
banks (NCBs). Under the MRO, the NCBs provide the majority of the liquidity to the banking
system in the euro area. MRO is conducted on a weekly basis and normally has a maturity of one
week. The refinancing rate of 1.00%, effective from May 13, 2009 till April 12, 2011, was the
lowest in the ECB’s 10-year history. The present rate is 1.25 per cent effective April 13, 2011.

MAIN REFINANCING OPERATIONS (MRO)

w.e.f. Refinancing Rate Action
(key ECB policy rate)

13-Apr-11 1.25% fixed up by 25 bp

13-May-09 1.00% fixed down by 25 bp
8-Apr-09 1.25% fixed down by 25 bp
11-Mar-09 1.50% fixed down by 50 bp
21-Jan-09 2.00% fixed down by 50 bp
10-Dec-08 2.50% fixed down by 75 bp
12-Nov-08 3.25% fixed down by 50 bp
15-Oct-08 3.75% fixed down by 50 bp
9-Jul-08 4.25% variable up by 25 bp

2. Deposit Facility: It enables commercial banks in the euro area to park their surplus funds with their
respective national central banks (NCBs) at this rate. It is an overnight facility. The present rate is 0.50%,
effective from April 13, 2011. (It is similar to Reserve Bank of India’s Reverse Repo rate under its Liquidity
Adjustment Facility.)

3. Marginal Lending Facility: It is an overnight facility by which liquidity is offered to the financial sector
from the eurosystem. It is a standing facility through which counterparties receive credit from a national
central bank at a pre-specified interest rate against eligible assets/securities. The present rate is 2.00%,
effective from April 13, 2011. (It is similar to RBI’s Repo rate under LAF.)

Rate Corridor: The interest rates on marginal lending facility and deposit facility normally provide a ceiling
and a floor for the overnight market interest rates. Overnight market rates are expected to move within this
corridor.

OVERNIGHT FACILITIES
Deposit Facility Marginal Lending Facility

w.e.f Rate Action w.e.f Rate Action

13-Apr-11 0.50% up by 25 bp 13-Apr-11 2.00% up by 25 bp
13-May-09 1.75% down by 50 bp
8-Apr-09 0.25% down by 25 bp 8-Apr-09 2.25% down by 25 bp
11-Mar-09 0.50% down by 50 bp 11-Mar-09 2.50% down by 50 bp
21-Jan-09 1.00% down by 100 bp 21-Jan-09 3.00% down by 75 bp
10-Dec-08 2.00% down by 75 bp
12-Nov-08 2.75% down by 50 bp 12-Nov-08 3.75% down by 50 bp
9-Oct-08 3.25% up by 50 bp 9-Oct-08 4.25% down by 50 bp
8-Oct-08 4.75% down by 50 bp
9-Jul-08 5.25% up by 25 bp

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 Rama Krishna Vadlamudi, HYDERABAD April 8, 2011
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com

ANNEXURE:
European Union enlargement:

The European Union (EU) was established on November 1, 1993 after the ratification of the
Maastricht Treaty by the member states. It was previously known as the European Economic
Community (EEC). It is a political and economic union of the member states, mainly consisting of
European nations. It aims to provide a single market for the member states. Its important
institutions include the European Commission, the European Parliament, the European Court of
Justice and the European Central Bank.

The EU is an amalgam of 27 Member States. In addition to the first six Member States of the
EEC — Belgium, France, Germany, Italy, Luxembourg and the Netherlands — additional 21
countries are now members of the Union. These are: Denmark, Ireland and the United Kingdom
(1973); Greece (1981); Spain and Portugal (1986); Austria, Finland and Sweden (1995); the
Czech Republic, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Poland, Slovenia and
Slovakia (2004); and Bulgaria and Romania (2007). Croatia, Macedonia and Turkey have been
waiting in the wings to join the EU.

EU Member State Date joined Adopted ‘Euro’ as

the EU common currency
Austria Jan. 1, 1995 Yes – wef 1.1.2002
Belgium Mar. 25, 1957 Yes – wef 1.1.2002
Bulgaria Jan. 1, 2007 No
Cyprus May 1, 2004 Yes – wef 1.1.2008
The Czech Republic May 1, 2004 No
Denmark Jan. 1, 1973 No
Estonia May 1, 2004 Yes – wef 1.1.2011
Finland Jan. 1, 1995 Yes – wef 1.1.2002
France Mar. 25, 1957 Yes – wef 1.1.2002
Germany Mar. 25, 1957 Yes – wef 1.1.2002
Greece Jan. 1, 1981 Yes – wef 1.1.2002
Hungary May 1, 2004 No
Ireland Jan. 1, 1973 Yes – wef 1.1.2002
Italy Mar. 25, 1957 Yes – wef 1.1.2002
Latvia May 1, 2004 No
Lithuania May 1, 2004 No
Luxembourg Mar. 25, 1957 Yes – wef 1.1.2002
Malta May 1, 2004 Yes – wef 1.1.2008
The Netherlands Mar. 25, 1957 Yes – wef 1.1.2002
Poland May 1, 2004 No
Portugal Jan. 1, 1986 Yes – wef 1.1.2002
Romania Jan. 1, 2007 No
Slovenia May 1, 2004 Yes – wef 1.1.2007
Slovakia May 1, 2004 Yes – wef 1.1.2009
Spain Jan. 1, 1986 Yes – wef 1.1.2002
Sweden Jan. 1, 1995 No
The United Kingdom Jan. 1, 1973 No

Note: Seventeen EU countries have adopted ‘euro’ as their common currency; while ten EU countries have not adopted
‘euro’ as their currency and continue to use their own national currencies.

Data is as on January 6, 2011 SOURCES: ECB, BBC, Britannica Encl, etc.

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