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.
Dear readers, we are greatly honored by your readership and sincerely hope that our special mixture of entertainment and education continues to add a little value to your lives. As you can probably guess, our blog is not really a giant commercial enterprise, for that its readership is too exclusive and small. Nevertheless, running it involves not only time and effort, but also monetary costs. We are therefore starting another fundraising drive. You can help us reach our funding goal by either donating directly via Paypal or via Bitcoin.
Thank you for your support!Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to “The ECB Rate Decision – A Brief Comment”
Most read in the last 20 days:
- The Stock Market in Trouble - How Bad Can it Get?
A Look at the Broader Market's Internals We have previously discussed the stock market's deteriorating internals, and in light of recent market weakness want to take a brief look at the broader market in the form if the NYSE Index (NYA). First it has to be noted that a majority of the stocks in the NYA are already in bearish trends. The chart below shows the NYA and the percentage of stocks above their 200 day and 50 day moving averages, which is 39.16% and 33.77% respectively. When...
- Gold Stocks at an Interesting Juncture
A Fascinating Parallel We have recently discussed the sentiment and positioning backdrop in gold on two separate occasion, as it has once again reached rarely encountered extremes (see “Gold Panic” and “Gold and the Grave Dancers” for details). Image via bullionstreet.com Not much has changed on that front, except for the fact that small speculators have increased their net short position in COMEX gold futures to the highest level in nearly three decades last...
- Gold Stocks: A Playable Rally May Be Beginning as Junk Bonds Crater
Gold Stocks Jump and Retrace 50% Last week we discussed the potential for a rally in the gold sector (see: “Gold Stocks at an Interesting Juncture” for details). Gold stocks jumped early in the week and then retraced almost precisely 50% of the initial move higher, in the process closing a gap that was left behind on Wednesday. Image credit: dreamstime.com Interestingly, for the first time in many months, there were three up days in a row prior to the...
- A new Multi-Year High in Buying by Gold Sector Insiders
Latest Data from INK Show A Huge Surge in Insider Buying As our friends at INK Research in Canada have pointed out to us, insiders at gold companies have made use of the recent sell-off in the sector to load up on shares to an extent not seen in many years. Image source: bidness etc The INK insider buy/sell indicator for gold stocks has peaked just one day after China's initial devaluation announcement at nearly 1,200%: INK's gold insider sentiment...
- The Trump Phenomenon
Surprising Success We were wondering a while if there was anything we could say about the highly entertaining real estate mogul who has successfully hijacked the Republican nomination process – apart from the fact that he is sporting a haircut that looks a bit like a helicopter landing pad, endowing him with instant recognizability: Teflon-Donald Trump, the unlikely front-runner with the interesting haircut Photo credit: Dominick Reuter / Reuters Of course...
- Is Crude Oil Close to a Low?
Panicky Headlines Everybody knows that there is a never-ending glut in crude oil, right? Who knew about it a year ago? Not everybody, that much is certain. The problem with what everybody knows is of course that it is often not worth knowing. Photo credit: Alamy Today a friend pointed two articles out to us that have been published yesterday and today. Their headlines say it all. The Wall Street Journal writes “No End in Sight for Oil Glut” - and proceeds to...
- The Stock Market's Panic Potential
The Odds Favor a “Warning Shot” Scenario - but there is a “But” As regular readers have probably noticed, we have upped the frequency of our “caution is advised” posts on the stock market in recent weeks in light of the market's increasingly deteriorating internals. Although one never knows when exactly such warning signs may begin to matter, it is always a good bet that they eventually will. Last week the market delivered a little wake-up call to the hitherto rather...
- The Donald and China, or The Fallacy of Protectionism
Not Every Populist Topic is Worth Exploiting For reasons that will forever remain a mystery to us, mercantilism and protectionism actually hold enormous popular appeal. The best explanation we can come up with for this phenomenon is that the support for such policies is based on a mixture of economic ignorance and relentless propaganda by vested interests over the past, say, four centuries. Still, it is almost comical that people are so vociferously clamoring for policies that can actually...
- The Economy is in Liquidation Mode
Capital Consumption If you’re an American over a certain age, you remember roller skating rinks (I have no idea if it caught on in other countries). This industry boomed in the 1970’s disco era. However, by the mid 1980’s, the fad was fading. Imagine running a rink company at the end of the craze. You know it is not going to survive for long. How do you operate your business? The birthplace of roller disco turned out to be edible, sort of Photo via...
- Monetary Metals Supply and Demand Report 9 August, 2015
Withdrawing the Gold Bid Last week, we left off with this: “Something is happening with gold…” It began in Dec 2008. To understand it, it is necessary to understand two principles. The first is that gold is money and the dollar is credit, which currently has nontrivial value. A dollar is worth 28.4mg gold. To understand the second, let’s look at how markets work at the mechanical level. An assortment of well-known bullion coins and bars from all...