ECB’s ‘whole menu’ bereft of new dishes

October 28, 2015

A freelance journalist eats his dinner behind a note advertising a "crisis menu" in a restaurant in SibiuECB President Mario Draghi’s ‘whole menu’ of monetary policy options to spur lending and boost euro area inflation from below zero appears to have few new dishes, if any at all.

A strong majority of forecasters say the ECB will announce in December an extension to its asset buying programme beyond the originally planned end date of September 2016, and maybe increase the size of its monthly purchases.

Given the emphasis policymakers have placed on the already negative deposit rate, economists predict the ECB will probably snip that too.

A negative deposit rate essentially penalises banks for parking money with the central bank. That should ideally prompt banks to lend surplus cash to each other instead and, in turn, to the real economy. In reality, it’s not so simple.

One euro area money market trader at a major dealer said:

As a result of the deposit rate cut down to -20 (basis points), we’ve seen some banks that we speak to, who have been active on the deposit market for literally decades, disappear completely.

In the end it will just cripple people’s interest in this market. If they say they want to increase interbank lending by forcing people to pay a premium on the money that they are holding, then that has failed. And it’s not going to work if they cut it to -40 or -50.

Going too deep into negative territory might even make banks transfer reserves into physical cash instead and make it harder for the ECB to buy bonds as part of QE.

Deposit rates below zero were first introduced by the ECB in June 2014 after it didn’t have any room left to cut its benchmark lending rate.

A raft of additional measures have kicked in since then, including loans specifically targeted at raising lending and a full-fledged quantitative easing programme.

But holding the deposit rate at -0.20 percent for over a year and spending 60 billion euros a month on buying mostly government bonds since March has done little to give confidence to banks to lend to each other, let alone to businesses.


Lending to private firms turned positive for the first time in three years in March but recent data showed it slipped again last month and is nowhere close to the pre-crisis double-digit numbers.

The ECB’s policy measures so far have not prompted upward revisions to inflation forecasts either.

On the contrary, predictions for both economic growth and inflation over the next two years were mostly trimmed in a Reuters poll of private forecasters taken two weeks ago.

The only impact another deposit rate cut could actually have is to stop the euro from rising, especially if the ECB announces more easing just as or after the U.S. Fed hikes rates.

According to economists at Credit Agricole:

In our view, a rate cut – and especially a deposit rate cut, as short-term rates track it more than the main refinancing rate – essentially aims to remove the upward pressure on the euro; the consequences for private-sector loans and longer rates are less clear.

Although Draghi has repeatedly emphasised that the exchange rate is not a policy target, a weaker euro that would make imports costlier and exports cheaper might be the only avenue left to push inflation higher.

And even then, it probably would not be significant enough on its own for the ECB to hit its near 2 percent inflation target.

With reporting by Siddharth Iyer and Sumanta Dey

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