Mario Draghi steers European Central Bank towards negative rates
Mario Draghi...President of European Central Bank Mario Draghi speaks during a news conference in Frankfurt, Germany, Thursday, Nov. 7, 2013, following a meeting of the ECB governing council. The ECB lowered its key interest rate from 0.5 to 0.25 per cent. (AP Photo/Michael Probst)©AP
President of European Central Bank Mario Draghi speaks during a news conference in Frankfurt
Mario Draghi’s hint that the European Central Bank is readying more monetary easing suggests that eurozone policy makers’ next move will take them where no big central bank has gone before: cutting one of its key interest rates below zero.
The ECB president said on Saturday, following the spring meetings of the International Monetary Fund and World Bank, that a strengthening of the euro “requires further monetary stimulus”.
Several officials have said cutting the rate the central bank pays on deposits parked at the ECB below the current level of zero would be their preferred option to tackle the single currency’s appreciation.
Eurozone policy makers hope a decision to join the very select group of central banks that have imposed negative interest rates will make it less attractive for banks and investors to hold euros by, in effect, charging a levy on savings in the single currency.
Mr Draghi’s words came amid demands from the IMF, finance ministers and central bankers gathered in Washington that the eurozone do more to stave off a damaging bout of low inflation, running at just a quarter of the central bank’s target.
A big reason why inflation is so low is the euro’s strength, which makes imports from outside the region less expensive, in turn lowering price pressures across the bloc.
The single currency has risen 6 per cent against the dollar and 9 per cent against the yen in the past year, and remains close to multiyear highs. This appreciation has come despite increasingly dovish noises from the ECB this month, including its strongest hint yet that it could embark on mass purchases of government bonds – known as quantitative easing.
The ECB used the weekend’s meetings to press the message that if it takes further action, it will cut interest rates – possibly into negative territory – before embarking on quantitative easing.
Only a few central banks, including Sweden’s Riksbank and Denmark’s National Bank, have ever tried negative deposit rates. The results were inconclusive.
Some eurozone policy makers say taxing banks for holding euros will spur lenders in the bloc’s core to channel funds to their counterparts in the region’s periphery, as well as encouraging investors to buy other currencies. If the euro fell, then it would become easier for the region’s businesses to sell their goods and services at home and abroad.
But others say negative rates could have unintended consequences and that cutting much below minus 0.25 per cent might prompt investors to simply hold cash instead. With little precedent, there is also considerable uncertainty about the impact of such a move on a currency as important as the euro, which is held by investors around the world.
In comments to journalists on Saturday, Mr Draghi reiterated that the ECB did not have a target in mind for the euro, but stressed that its appreciation over the past year “was important for price stability”.
“The strengthening of the exchange rate would require – to make our monetary stance equally accommodative – further monetary policy accommodation,” Mr Draghi said, adding: “The strengthening of the exchange rate requires further monetary stimulus. That is an important dimension for us”.
The comments mark the latest attempt by Mr Draghi to talk down the euro.
Mr Draghi believes the euro’s strength is one of the most important reasons for the disinflationary trend in the currency bloc. The ECB president says that the euro’s appreciation has knocked between 0.4 and 0.5 percentage points off inflation since 2012.
Crucially, Jens Weidmann, Bundesbank president and the ECB governing council’s arch hawk, said last month negative rates were the best defence against a strong euro – signalling he would also support this approach ahead of quantitative easing.
The Bundesbank is unlikely to back further policy easing until the ECB announces a fresh forecast for inflation in June, however. Germany’s central bank wants to be convinced that Europe’s undershooting of its “below but close to 2 per cent” inflation target will be breached for a prolonged period. Still, a lower than expected reading for inflation this month could prompt the majority of the committee to vote for action before then.
Inflation is expected to bounce this month to about 0.9 per cent, after falling to 0.5 per cent in March – its lowest level in more than four years.
When interest rates go negative:
The idea of paying a bank to park your savings there, at first glance, appears bizarre.
But, crazy as it might seem, with interest rates close to zero around the globe and central bankers desperate for growth, some of the world’s monetary guardians have already resorted to this measure.
The ECB has now sent out a strong signal that it could be next, indicating it will turn interest rates negative to counter any further strengthening of the euro.
The negative rate would be applied on one of the ECB’s three key interest rates: the deposit rate. The deposit rate, now at zero, is the interest rate the ECB pays on the reserves that banks hold at the central bank.
If policy makers cut the rate below zero to, say, minus 0.1 per cent, then banks would have to pay the central bank an annual rate of 0.1 per cent on reserves parked overnight at the ECB.
The ECB is hoping that this fee would encourage banks to increase lending to credit-starved businesses.