MacroScope

A negative ECB deposit rate: “What difference would it make?”

May 23, 2014

A chef slices a portion of greater amberjack while preparing sashimi at the Akasaka Umaya Japanese-style restaurant in TokyoThe European Central Bank will probably cut its deposit rate below zero in a few weeks, charging banks to park money with it.

What is striking is how many analysts and money market traders alike think the net result will be neutral at best.

The trouble is, with few options left and strong hints from the ECB that it is on the verge of action, it is also clear that not cutting the deposit rate would probably do harm by pushing money market rates higher.

Twenty-nine of 41 economists polled by Reuters this week expect the ECB to cut the deposit rate at its June meeting, with most saying to -0.10 percent from zero presently.

The ECB has been considering such a move for a while now, but has been reluctant to do it.

With the refinancing rate now at just 0.25 percent and also expected to fall, the ECB now has little choice without narrowing the rate “corridor” – the difference between the two – to next to nothing.

But previous attempts by other central banks to charge commercial banks for depositing cash temporarily didn’t work so well, and it could end up doing more harm than good.

After the Danish and Swiss central banks tried the same thing in 2012, commercial banks passed on the cost they incurred to park funds over to their own clients. Some analysts are wary of that same experience repeating itself.

But the problem is the ECB now appears to have boxed itself into delivering, no matter what the consequences.

“The ECB will cut deposit rate only to follow up on their promise last month and not disrupt markets,” said a money market trader at one of the biggest European dealers. Twenty traders polled by Reuters on Friday were similarly unmoved.

With expectations so low, that does not give the impression it will be a resounding success.

And there are plenty of analysts who are concerned it might actually have unintended negative consequences.

“A negative deposit rate is a questionable move, with distortive effects and limited scope to generate a material and sustainable weakening of the currency,” wrote analysts at UniCredit in a report to clients.

The good news for the ECB is that the euro has weakened substantially after coming close to testing $1.40 – now trading below $1.37 after a series of disappointing economic releases. But with so many long positions, that might not last.

Mark Wall, European economist at Deutsche Bank said: “a wide package of measures is coming – the Council has talked about it for over a year, they are finally willing to implement them – but how successful will that be? We don’t really know.”

“It’s not the sort of policy that has been implemented in many countries so lots of questions are raised – it will be symbolic, more than anything else. There may be unintended consequences, which the ECB has not addressed.”

A deposit rate cut, twinned with appropriate incentives, possibly another flood of cheap loans with conditions attatched, could push commercial banks to lend more to businesses and boost the economy, which is what the ECB wants.

But most are not convinced.

“What difference does it make?” asked a money market trader at a large European dealer.

And while it’s fairly clear any impact on money market rates will be marginal at best, no interest rate move at the zero bound will do anything meaningful on its own to tackle some of the region’s biggest economic worries, like high unemployment.

“Half of zilch is neither here nor there,” said Nicole Elliott, a technical analyst and private investor.

“As a previous Bundesbank chief said many years ago, it’s ‘like pushing on a piece of string’. The real story is that central bankers can no longer lord it over mere mortals.”

– Reporting by Ashrith Rao Doddi and Rahul Karunakar

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