ECB's revolutionary move aims to force banks to pay a charge if they continue to park money for safe-keeping in Frankfurt
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8:11PM BST 05 Jun 2014 The Telegraph
The European Central Bank has become the first of the world’s monetary superpowers to cut its deposit rate below zero, taking a leap into the unknown as it tries to drive down the euro and head off deflation.
The bank opened the door to direct purchases of private assets or quantitative easing, and announced a €400bn blast of long-term lending at cheap rates for banks.
The benchmark interest rate was cut to a record low of 0.15pc, tantamount to zero. The revolutionary move was to lower the deposit rate to -0.1pc, forcing banks to pay a charge if they continue to park money for safe-keeping in Frankfurt.
“Are we finished? The answer is no,” said Mario Draghi, the ECB’s president. “If required, we will act swiftly with further monetary policy easing. The Governing Council is unanimous in its commitment to using unconventional instruments within its mandate should it become necessary to further address risks of prolonged low inflation.”
The rate cuts prompted fury in Germany, where the head of the German Association of Savings Banks, Georg Fahrenschon, accused the ECB of expropriating savers. “We are tearing a hole in the pensions of savers. Over time these low rates will destroy the value of assets,” he said.
Der Spiegel deemed it was the “end of capitalism”, while Die Welt described Mr Draghi as Europe’s Bismarck, a near autocrat beyond control. It is a foretaste of what may happen if the ECB does graduate to QE later this year, once the machinery is ready.
David Marsh, head of the financial forum OMFIF, said the latest stimulus is mostly window dressing and may backfire. “The fear is that it cannot and will not provide the massive impulse needed to return the euro area to full health. But it will nonetheless be more than sufficient to antagonise public opinion in Germany,” he said.
The anti-euro party Alternative fur Deutschland won seven seats in the European Parliament in last month’s elections, giving it a platform for the first time.
In an extraordinary development, Germany’s finance minister, Wolfgang Schäuble, has called into question the backstop plan for Italian and Spanish bonds unveiled with spectacular effect by Mr Draghi two years ago, saying the scheme cannot go ahead without German consent and “we will not approve of such a programme”. The comments yet again call into question how far Germany is willing to go keep the system together.
David Owen, from Jefferies Fixed Income, said the lending measures offer more than meets the eye and amount to a mini-bazooka. “Draghi has drawn a line in the sand and is telling us that he is not going to raise interest rates for four years. This is highly significant,” he said.
Banks will be able to borrow €400bn for four years at near zero rates at LTRO (long-term refinancing operation) auctions in September and December. The magic is in the details. While the sums are far lower than earlier LTRO auctions, the banks will be able to tap the ECB for funds equal to 7pc of their private loan book without using up collateral. “They can get free money for four years so long as they lend it to the real economy,” he said.
ECB officials hope that this will unlock a surge of lending. The aim is to stop “passive tapering” as banks rush to repay loans and beef up capital ratios, a phenomena that has caused the ECB’s balance sheets to shrink by €800bn.
Mr Draghi has also copied a tool deployed by the Bank of Japan in February, letting banks obtain liquidity equal to three times their lending. The first trickle of QE is coming through as €165bn bonds held from an earlier scheme are no longer “sterilised”, but the pace will be glacial.
The ECB package of emergency measures is in striking contrast with developments in the US and Britain, where central banks are moving toward the exit door, deeming the job done.
It underscores the gravity of the crisis in Europe, where lending to the private sector is declining at a rate of 1.8pc and several countries are in deflation. Italy, Holland and Portugal relapsed into economic contraction in the first quarter, while France fell back to zero growth. The recovery is in danger of withering on the vine.
The blitz comes late, with EMU inflation already down to 0.5pc. The ECB slashed its inflation forecast for this year to 0.7pc, making a mockery of the coming stress test for banks, which deems 1pc to be the most extreme “adverse scenario”.
The ECB also lowered its inflation estimate to 1.1pc in 2015 and 1.4pc in 2016, showing how far it has strayed from its 2pc target. Mr Draghi has warned in the past of a “pernicious negative spiral” in prices, but insisted that their is currently no “self-fulfilling” dynamic at work pulling Europe into a trap.
Even so, the prolonged effects of “lowflation” are serious, since any drop in the rate at this stage can have powerful effects on the intensity of debt-deflation in the crisis countries. It is a key reason why debt ratios keep spiralling higher despite austerity cuts.
Danae Kyriakopoulou, from the Centre for Economics and Business Research, said the negative deposit rate may do more harm than good. Banks hold just €30bn in cash reserves at the ECB – down from €700bn in mid-2012 – so the move will not free up much money for lending.
“What we may see instead is deposit flight as savers look for banks more willing to take on their cash elsewhere, as happened in Denmark. This in turn could even lead to a fall in lending, making the rate cut effectively contractionary, and do little to raise eurozone inflation,” she said.
The negative deposit rate risks causing havoc in the money market industry, one reason why the US Federal Reserve never tried it. The industry is worth €843bn in Europe, of which €375bn is from foreign funds.
The ECB is clearly hoping that some of this money will drift away, pulling down the euro exchange rate, which has strengthened 5pc in the past year and pushed the bloc closer to deflation. Early on Thursday the euro plunged one cent against the US dollar to $1.35 but bounced back and ended slightly higher.
Hans Redeker, currency chief at Morgan Stanley, said it will be a struggle to weaken the euro for long given the eurozone’s ballooning current account surplus of €280bn and the repatriation of funds by banks shoring up defences at home. “The ECB has bought time but Europe’s banks are incapable of recycling the surplus,” he said.
The stock markets rallied by 1pc in France, 1.1pc in Spain and 1.5pc in Italy on the historic measures, though reaction in Germany was muted. Many of the details were flagged in advance. Jens Nordvig, from Nomura, said credit markets have already priced in near perfection. It may take “broad-based” asset purchases to keep the rallies going.
Full-blown QE is not yet on the cards, though the ECB has a €1 trillion plan for use in extremis. Mr Draghi said the bank wants to “signal” that it is willing to buy asset-back securities if need be. They would be packages of loans but not the incendiary concoctions that led to the US subprime crisis. “They should be simple, not CDS (collateralised debt securities) cubed, or squared. They should be real loans, not based on derivatives,” he said.
It is an immature market in Europe, with just €700bn of assets to buy, and it is unclear whether purchases of asset-backed securities can direct much lending to small businesses, where it is most needed. It is costly to put together packages of sellable loans for family firms. “Their importance to politicians far outstrips their attractiveness to creditors,” said Matt King, from Citigroup.
In the end, the ECB may have to bite the bullet and resort to full-blown purchases of sovereign debt, just like the central banks of the US, Britain and Japan. That thorny issue has been put off for a few more months while the ECB prays for a miracle.
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