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!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

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:

  • Too Much Bubble-Love, Likely to Bring Regret
      Unprecedented Extremes in Overbought Readings Readers may recall our recent articles on the blow-off move in the stock market, entitled Punch-Drunk Investors and Extinct Bears (see Part 1 & Part 2 for the details). Bears remained firmly extinct as of last week – in fact, some of the sentiment indicators we are keeping tabs on have become even more stretched, as incredible as that may sound. For instance, assets in bullish Rydex funds exceeded bear assets by a factor of more than 37...
  • How to Buy Low When Everyone Else is Buying High
      When to Sell? The common thread running through the collective minds of present U.S. stock market investors goes something like this: A great crash is coming.  But first there will be an epic run-up climaxing with a massive parabolic blow off top.  Hence, to capitalize on the final blow off, investors must let their stock market holdings ride until the precise moment the market peaks – and not a moment more.  That’s when investors should sell their stocks and go to...
  • What Kind of Stock Market Purge Is This?
      Actions and Reactions Down markets, like up markets, are both dazzling and delightful. The shock and awe of near back-to-back 1,000 point Dow Jones Industrial Average (DJIA) free-falls is indeed spectacular. There are many reasons to revel in it.  Today we shall share a few. To begin, losing money in a multi-day stock market dump is no fun at all.  We'd rather get our teeth drilled by a dentist.  Still, a rapid selloff has many positive qualities.   Memorable moments from...
  • Monetary Metals Brief 2018
      Short and Long Term Forecasts Predicting the likely path of the prices of the metals in the near term is easy. Just look at the fundamentals. We have invested many man-years in developing the theory, model, and software to calculate it. Every week we publish charts and our calculated fundamental prices.   A selection of 1 and ½ ounce gold bars – definitely more fondle-friendly than bitcoin, but a bit more cumbersome to send around. [PT]   However, predicting the...
  • The Donald Saves the Dollar
      Something for Nothing The world is full of bad ideas.  Just look around.  One can hardly blink without a multitude of bad ideas coming into view.  What’s more, the worse an idea is, the more popular it becomes. Take Mickey’s Fine Malt Liquor.  It’s nearly as destructive as prescription pain killers.  Yet people chug it down with reckless abandon.   Looking at the expression of this Mickey's Malt Liquor tester one might initially get the impression that he is...
  • US Stocks - Minor Dip With Potential, Much Consternation
      It's Just a Flesh Wound – But a Sad Day for Vol Sellers On January 31 we wrote about the unprecedented levels - for a stock market index that is - the weekly and monthly RSI of the DJIA had reached (see: “Too Much Bubble Love, Likely to Bring Regret” for the astonishing details – provided you still have some capacity for stock market-related astonishment). We will take the opportunity to toot our horn by reminding readers that we highlighted VIX calls of all things as a worthwhile...
  • Why I Own Gold and Gold Mining Companies – An Interview With Jayant Bandari
      Opportunities in the Junior Mining Sector Maurice Jackson of Proven and Probable has recently interviewed Jayant Bandari, the publisher of Capitalism and Morality and a frequent contributor to this site. The topics discussed include currencies, bitcoin, gold and above all junior gold stocks (i.e., small producers and explorers). Jayant shares some of his best ideas in the segment, including arbitrage opportunities currently offered by pending takeovers – which is an area that generally...
  • “Strong Dollar”, “Weak Dollar” - What About a Gold-Backed Dollar?
      Contradictory Palaver The recent hullabaloo among President Trump’s top monetary officials about the Administration’s “dollar policy” is just the start of what will likely be the first of many contradictory pronouncements and reversals which will take place in the coming months and years as the world’s reserve currency continues to be compromised.  So far, the Greenback has had its worst start since 1987, the year of a major stock market reset.   A modern-day...
  • Seasonality of Individual Stocks – an Update
      Well Known Seasonal Trends Readers are very likely aware of the “Halloween effect” or the Santa Claus rally. The former term refers to the fact that stocks on average tend to perform significantly worse in the summer months than in the winter months, the latter term describes the typically very strong advance in stocks just before the turn of the year. Both phenomena apply to the broad stock market, this is to say, to benchmark indexes such as the S&P 500 or the...
  • The FOMC Meeting Strategy: Why It May Be Particularly Promising Right Now
      FOMC Strategy Revisited As readers know, investment and trading decisions can be optimized with the help of statistics. One way of doing so is offered by the FOMC meeting strategy.   The rate hikes are actually leading somewhere – after the Wile E. Coyote moment, the FOMC meeting strategy is especially useful [PT]   A study published by the Federal Reserve Bank of New York in 2011 examined the effect of FOMC meetings on stock prices.  The study concluded that these...
  • The Future of Copper – Incrementum Advisory Board Meeting Q1 2018
      Copper vs. Oil The Q1 2018 meeting of the Incrementum Fund's Advisory Board took place on January 24, about one week before the recent market turmoil began. In a way it is funny that this group of contrarians who are well known for their skeptical stance on the risk asset bubble, didn't really discuss the stock market much on this occasion. Of course there was little to add to what was already talked about extensively at previous meetings. Moreover, the main focus was on the topic...
  • When Budget Deficits Will Really Go Vertical
      Mnuchin Gets It United States Secretary of Treasury Steven Mnuchin has a sweet gig.  He writes rubber checks to pay the nation’s bills.  Yet, somehow, the rubber checks don’t bounce.  Instead, like magic, they clear. How this all works, considering the nation’s technically insolvent, we don’t quite understand.  But Mnuchin gets it.  He knows exactly how full faith and credit works – and he knows plenty more.   Master of the Mint and economy wizard Steven Mnuchin and...

Support Acting Man

Item Guides

Top10BestPro
j9TJzzN

Austrian Theory and Investment

Archive

350x200

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

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com