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:

  • America Goes Full Imbecile
      Credit has a wicked way of magnifying a person’s defects.  Even the most cautious man, with unlimited credit, can make mistakes that in retrospect seem absurd.  But an average man, with unlimited credit, is preeminently disposed to going full imbecile.   Let us not forget about this important skill...  [PT]   Several weeks ago we came across a woeful tale of Mike Meru.  Somehow, this special fellow, while of apparent sound mine and worthy intent, racked up...
  • Retail Capitulation – Precious Metals Supply and Demand
      Small Crowds, Shrinking Premiums The prices of gold and silver rose five bucks and 37 cents respectively last week. Is this the blast off to da moon for the silver rocket of halcyon days, in other words 2010-2011?   Various gold bars. Coin and bar premiums have been shrinking steadily (as have coin sales of the US Mint by the way), a sign that retail investors have lost interest in gold. There are even more signs of this actually, and this loss of interest stands in stark...
  • Credit Spreads: Polly is Twitching Again - in Europe
      Junk Bond Spread Breakout The famous dead parrot is coming back to life... in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” - mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while...
  • Gold Divergences Emerge
      Bad Hair Day Produces Positive Divergences On Friday the ongoing trade dispute between the US and China was apparently escalated by a notch to the next level, at least verbally. The Trump administration announced a list of tariffs that are supposed to come into force in three week's time and China clicked back by announcing retaliatory action. In effect, the US government said: take that China, we will now really hurt our own consumers!  - and China's mandarins replied: just you wait, we...
  • Industrial Commodities vs. Gold - Precious Metals Supply and Demand
      Oil is Different Last week, we showed a graph of rising open interest in crude oil futures. From this, we inferred — incorrectly as it turns out — that the basis must be rising. Why else, we asked, would market makers carry more and more oil?   Crude oil acts differently from gold – and so do all other industrial commodities. What makes them different is that the supply of industrial commodities held in storage as a rule suffices to satisfy industrial demand only for a...
  • Chasing the Wind
      Futility with Purpose Plebeians generally ignore the tact of their economic central planners.  They care more that their meatloaf is hot and their suds are cold, than about any plans being hatched in the capital city.  Nonetheless, the central planners know an angry mob, with torches and pitchforks, are only a few empty bellies away.  Hence, they must always stay on point.   Watch for those pitchfork bearers – they can get real nasty and then heads often roll quite literally....
  • Lift-Off Not (Yet) - Precious Metals Supply and Demand
      Wrong-Way Event Last week we said something that turned out to be prescient:   This is not an environment for a Lift Off Event.   An unfortunate technical mishap interrupted the latest moon-flight of the gold rocket. Fear not true believers, a few positive tracks were left behind. [PT]   The price of gold didn’t move much Mon-Thu last week, though the price of silver did seem to be blasting off. Then on Friday, it reversed hard. We will provide a forensic...
  • Merger Mania and the Kings of Debt
      Another Early Warning Siren Goes Off Our friend Jonathan Tepper of research house Variant Perception (check out their blog to see some of their excellent work) recently pointed out to us that the volume of mergers and acquisitions has increased rather noticeably lately. Some color on this was provided in an article published by Reuters in late May, “Global M&A hits record $2 trillion in the year to date”, which inter alia contained the following chart illustrating the...
  • Cryptocurrency Technicals – Navigating the Bear Market
      A Purely Technical Market Long time readers may recall that we regard Bitcoin and other liquid big cap cryptocurrencies as secondary media of exchange from a monetary theory perspective for the time being. The wave of speculative demand that has propelled them to astonishing heights was triggered by market participants realizing that they have the potential to become money. The process of achieving more widespread adoption of these currencies as a means of payment and establishing...
  • The Fed's “Inflation Target” is Impoverishing American Workers
      Redefined Terms and Absurd Targets At one time, the Federal Reserve's sole mandate was to maintain stable prices and to “fight inflation.”  To the Fed, the financial press, and most everyone else “inflation” means rising prices instead of its original and true definition as an increase in the money supply.  Rising prices are a consequence – a very painful consequence – of money printing.   Fed Chair Jerome Powell apparently does not see the pernicious effects...
  • A Walk on the Wild Side
      A Walk on the Wild Side   “Never play cards with a man called Doc.  Never eat at a place called Mom’s.  Never sleep with a woman whose troubles are worse than your own.” – Nelson Algren, A Walk on the Wild Side   Fresh Fruit or Rotting Vegetables? A subtle gas seems to always be vented into the atmosphere at the sunset of an extended bull market.  As the light fades, an odor that’s indiscernible from that of fresh fruit or rotting vegetables wafts down...

Support Acting Man

Item Guides

j9TJzzN

The Review Insider

Dog Blow

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]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com