ECB Cuts Rates From 'Almost Nothing' to 'Next-to-Nothing'

Yesterday the ECB 'surprised' many market observers by making a major move in its interest rate policy at its meeting in Bratislava. This is unusual as the ECB is known for preferring to announce major decisions in Frankfurt, where its headquarters are situated.

Anyway, apparently the governing council thought the current economic situation required 'swift action' and thus decided to cut its repo rate from 75 to 50 basis points, the marginal lending facility's rate from 150 to 100 basis points, while leaving the deposit rate at zero. Concurrently Draghi announced in his press conference that the various special liquidity provisions offered by the ECB to banks (LTROs, ELA and so forth) will be subject to full allotment until the summer of 2014 at a minimum, and thereafter for 'as long as needed'.

It also became known that German governing board member Jörg Asmussen apparently voted against the rate cut (but curiously, BuBa president Jens Weidmann is said to have voted for it). Asmussen argued that it could not possibly make a difference whether the ECB charged 50 or 75 basis points – especially considering that banks with access to interbank markets can refinance themselves at an EONIA rate of about 5 to 7 basis points these days, i.e. basically 'nothing'. Asmussen is of course correct. At best the rate cut may have a psychological effect and even that is highly questionable. It certainly won't magically lift the euro area out of recession. Note in this context that euro-area wide unemployment has recently hit a new record high of 12.1%.


Given that administered rates are already extremely low, the danger of spurring more capital malinvestment is actually quite high, especially in places like Germany, where the economy is doing comparatively well. Hence Amsussen's dissent.


Draghi's Press Conference

Much was made of an off-hand remark by ECB chief Mario Draghi at the press conference with respect to the ECB's deposit rate. The deposit rate is the rate paid by the ECB on excess reserved deposited with it by commercial banks. When this rate was cut to zero last year,  over half of the excess reserves were immediately moved out of the ECB's deposit facility and into the euro-system's current account facility, where they continue to linger (less LTRO repayments that have been effected in the meantime).  One of the journalists asked Draghi whether he would be open to introducing a penalty rate on excess reserves, this is to say a 'negative interest rate'. Draghi mumbled something about his 'mind being open' about the possibility, after previously expressing caution regarding possible unintended consequences.

Such negative interests on deposit facilities were previously implemented in Denmark and Sweden, and in the former there were indeed 'unintended consequences' if memory serves (mainly in terms of creating interest expenses of 500 m. Danish crowns for the banks per year, something they could ill afford). On the other hand, given that the central bank's deposit facility is by far the safest type of demand deposit in existence – the central bank can never 'run out' of money after all – it should actually charge a fee for its use.

It is actually wrong to call this fee a 'negative interest rate'. Negative interest rates are an impossibility, as they would violate the law of time preference. Future goods cannot be worth more than present goods. If we knew for certain that the world will go under in a week's time (say via an asteroid strike), the discount of future goods versus present goods may well approach infinity, but the opposite can never happen.

Anyway, in our view the possibility of the ECB charging a penalty rate on excess reserves in its deposit facility isn't worth the attention it apparently received – simply because banks will then move the funds into the current account facility. We doubt it will create an incentive for them to increase their lending, and evidently the interbank market is already drowning in liquidity – as indicated by current EONIA rates of 5 to 7 basis points.

Draghi noted that the central bank stands 'ready to do more if needed' and also indicated that while there was a broad consensus regarding the 25 basis points cut in the repo rate, there were apparently also a few board members who apparently argued in favor of a bigger cut (this can only be inferred from his remarks, he didn't say so explicitly). He also expressed a desire for the creation of a larger ABS market in Europe, as the ECB is slowly but surely running out of assets to buy. Since the ECB is forbidden from providing monetary financing to governments, the choice of assets it can buy in order to implement something akin to 'quantitative easing' is rather limited. We are fairly sure though that the central bank will be able to overcome any impediments to more money printing when occasion seems to demand it.

Aside from these technicalities, there was one remark Draghi made that struck us as quite interesting. He was repeatedly asked about the 'austerity versus growth' debate that has recently flared up again after spreadsheet errors were discovered in the famous Reinhart-Rogoff paper on the connection between public debt and economic growth (we have discussed this topic previously). One question was: “Is the ECB the last defender of the austerity policy left standing?” This question was motivated by Draghi's introductory remarks, which included an admonition to euro area governments to continue with fiscal consolidation.

On this Draghi noted that many governments made their decisions regarding austerity under duress at a time when market pressures were intense. As a result, they chose the 'easy way' by mainly raising taxes. According to Draghi, this is the wrong way to go about austerity. Governments should rather look toward cutting spending and implementing reforms he said. Now that the immediate pressure is gone, they should actually think about cutting taxes in concert with cutting spending.

In spite of our general distaste of central banks, we have to agree with Draghi on all of this. This is precisely how austerity should be implemented – by cutting spending, cutting taxes and implementing reforms in the form of a liberalization of labor markets and the rescission of the jungle of stifling regulations that represents such a huge obstacle to business in Europe. Whether Draghi's views on this will carry water with the rapacious governments of Europe remains to be seen. We have grave doubts about that, but it is nevertheless refreshing that he is advocating a different approach.


One Size Fits All?

Draghi was forced to admit that the business cycle in various euro area member nations is not aligned. As a result, the ECB is facing an even more impossible task than other central banks when deciding on where interest rates should be fixed. He could not provide a satisfactory answer to how this problem could possibly be resolved, apart from noting that the recession is now spreading to the euro area's 'core' as well, which in his opinion makes the ECB's current loose monetary policy appropriate for all member nations.

However, the danger of an unsustainable asset price boom forming in places like Germany seems to us to be very real. Even chancellor Merkel seems to have recognized this, as she recently noted that for Germany higher interest rates would likely be appropriate at this stage. The German banking association recently also issued a warning that the ECB's loose monetary policy might cause a bubble in Germany.

We actually think that this is precisely the gravest danger the ECB's current policy stance is creating. The boom-and-bust see-saw in the euro area is likely to simply shift from South to North this time around, with the previous 'sick man of Europe' becoming the center of a new bubble, while the periphery goes through a depression. Obviously it is impossible for the central bank to keep such developments under control. This is also why we believe that the ECB's obsession about the 'monetary policy transmission' problem is quite unhealthy.  If interest rates in euro area countries were simply left to the market, they would certainly be diverging quite a bit, and it is a good bet that German rates would be higher than they actually are at present. Central planning of money doesn't work, and it does even less so in the euro area.





Emigrate While You Can... Learn More




Dear readers - we want to once again thank all of you who have supported us with donations.


To donate Bitcoins, use this address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke


Thank you for your support!

One Response to “The ECB Rate Decision – A Brief Comment”

  • I think negative rates are the idea of some mad scientist. They don’t seem to understand the money has to be somewhere and talk about deflation? Charging for money by discounting it over time, almost in a reverse manner would shrink the money supply. It would also be a violation of the contract. Maybe these neo-Keynesians don’t particularly care about principals and honesty? Clearly, they are into making up stories about why their policies aren’t working. The banks would likely ask for new denominations of notes, registered to them and hold their own reserves. 80 years ago, there were $100,000 notes in the US, never circulated. I’m sure they were like the President, their whereabouts known at all times.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • testa-e-collo-di-cesareWhy Do We Let Other People Tell Us What to Do?
      Lame Theories of Government We have been disappointed with political ideas and theories of government. They are nothing but scams, justifications, and puffery. One tries to put something over on the common man… the other claims it was for his own good… and the third pretends that he’d be lost without it. Most are not really “theories” at all… but prescriptions, blueprints for creating the kind of government the “theorist” would like to have. Not surprisingly, it is a...
  • goldmine-700x360Gold and Gold Stocks – Back to Tricky, but Interesting Signals Emerge
      A Relentless Short Term Decline When we last discussed the gold sector, we noted that with gold approaching its 200 day moving average, a pullback had to be expected soon. In the meantime, a bit more than just a pullback has happened, as a severe sell-off started after the October FOMC announcement.   Photo via   However, as you will see below, this has most likely merely reset the clock a bit in terms of anticipating a medium term trend change (even if...
  • MponengGold and Gold Stocks – It Gets Even More Interesting
      Technical Backdrop If only we could get a dime for every bearish article on gold that has been published over the past two weeks...but one can't have everything. When a market is down 83% like the HUI gold mining index is, we are generally more interested in trying to find out when it might turn around, since it is a good bet that it is “oversold”. Of course, it if makes it to 90% down, it will still be a harrowing experience in the short term. We like these catastrophes because...
  • resultThe Greatest Racket of All Time
      The Successes of the Global War on Terror One would think that the so-called “Global War on Terror”, which has been given fresh impetus by the Paris attacks, must be going swimmingly. What else could explain the great enthusiasm with which it is pursued? It may be recalled that it started in earnest after the WTC attack – also a declaration of war, as it was put at the time. As is often the case when Islamist fundamentalists strike, the actual attackers immolated themselves on...
  • winterThe Long, Cold Winter Ahead
      Not Immune Cold winds of deflation gust across the autumn economic landscape.  Global trade languishes and commodities rust away like abandoned scrap metal with a visible dusting of frost.  The economic optimism that embellished markets heading into 2015 have cooled as the year moves through its final stretch.   Photo credit: David Byrne   If you recall, the popular storyline since late last year has been that the U.S. economy is moderately improving while the...
  • santaHow Do People Destroy Their Capital?
      There is no Santa Claus I have written previously about the interest rate, which is falling under the planning of the Federal Reserve. The flip side of falling interest rates is the rising price of bonds. Bonds are in an endless, ferocious bull market. Why do I call it ferocious? Perhaps voracious is a better word, as it is gobbling up capital like the Cookie Monster jamming tollhouses into his maw. There are several mechanisms by which this occurs, let’s look at one...
  • oil rigJunk Bonds Under Pressure
      While the Stock Market is Partying ... There are seemingly always “good reasons” why troubles in a sector of the credit markets are supposed to be ignored – or so people are telling us, every single time. Readers may recall how the developing problems in the sub-prime sector of the mortgage credit market were greeted by officials and countless market observers in the beginning in 2007.   Photo credit: Getty Images   At first it was assumed that the most highly...
  • Young-European-Jihadists-ChappatteAngry Belgian Muslims and the Price of Welfare Statism
      Ill-Tempered Mohammedans in the Socialist Paradise In the wake of recent revelations about the identities of the morons involved in the horrific Paris attacks (happily, most of them shuffled off the mortal coil as well, thereby improving the aggregate degree of moral clarity and intelligence in the world), a friend pointed us to an article at Unz Review that asks: “Why Does Belgium Have Such Angry Muslims?” Our instinctive, immediate reaction was to argue that the bland, boring...
  • Chart-intraday averageCan Investors Trust the New Gold Fixing?
      Statistical Analysis of the New Gold Fixing   Since 20 March 2015 a new gold price fixing organized by the London Bullion Market Association has been in operation. It has replaced the previous price determination process, which was in place for more than a century and became subject to criticism as it was highly vulnerable to manipulation. Has manipulation now ceased?   Gold fixing at N.M. Rothchild and Sons offices in London. The first fixing took place there on 12 September...
  • trudeau-harperIncumbents Swept from Office Around the World
      Election Trends in 2015 – No Incumbent is Safe In the political sphere, this year has started with a bang, when Syriza won the Greek parliamentary election. All of Europe's attention was focused on this outcome and its aftermath over the coming six months or so. As it turned out, it was a bad omen for political incumbents nearly everywhere. More recently, we have seen the government of Stephen Harper in Canada go down in flames, with its opponents winning an unexpected landslide...

Support Acting Man




Own physical gold and silver outside a bank

Realtime Charts


Gold in USD:

[Most Recent Quotes from]



Gold in EUR:

[Most Recent Quotes from]



Silver in USD:

[Most Recent Quotes from]



Platinum in USD:

[Most Recent Quotes from]



USD - Index:

[Most Recent USD from]


THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Buy Silver Now!
Buy Gold Now!