Negative talk about whether negative rates really work on the rise

May 31, 2016

Mario Draghi, President of the European Central Bank (ECB), addresses the media during the ECB's monthly news conference in Frankfurt, September 4, 2014. The ECB cut interest rates to a fresh record low on Thursday and launched a new scheme to push money into the flagging euro zone economy. In a series of measures underscoring growing concern about the currency bloc's health, the ECB cut its main refinancing rate to 0.05 percent from 0.15 percent previously and drove the overnight deposit rate deeper into negative territory, now charging banks 0.20 percent to park funds with it. REUTERS/Kai Pfaffenbach (GERMANY - Tags: BUSINESS HEADSHOT) - RTR44XMB

Negative interest rates as a monetary policy tool will probably be around a while yet, but a backlash questioning their long-run benefits for Europe and just how low they can go before they do real harm appears to be growing.

An increasing proportion of professional forecasters appear to be turning against the view the European Central Bank’s negative deposit rate is good policy, considering how it squeezes the lending margins for banks and pushes some to just hold cash for fear of losing money on deposits.

Up until about half a decade ago, a central bank printing billions worth of money through buying government bonds for its own account was the most unconventional monetary policy used in modern times anywhere outside of Japan. But then all the big central banks started doing it: the Federal Reserve, the Bank of England, and belatedly, the ECB.

Now, about a fifth of global output comes from economies where an even more unconventional policy, negative interest rates, has gained a foothold. They are in active use by the central banks of Denmark, Switzerland, Sweden, the euro zone, and just this year, Japan.

The official rhetoric so far is that the negative deposit rate is working and there are no unwanted side effects.

ECB policymakers meeting this week are likely to maintain the status quo on policy, holding the refinancing rate at zero, the deposit rate at -0.4 percent and waiting to see the effects from its asset purchase programme that is just ramped up in March to 80 billion euros a month, along with the purchase of corporate bonds later this year and even more cheap long-term funds for banks.

But the percentage of respondents who said the ECB’s negative rates will do more harm than good has more than doubled to 44 percent from 21 percent in the last two Reuters polls on the subject. Of the 18 common banks between the April and May polls, six have converted from saying it is not harmful to saying it is. One bank said the opposite.

To be fair, the sample sizes were different: in April there were 28 respondents for that particular question while in May there were 54.  And the majority view remains that negative rates are doing the economy some good. But a third of the common banks changing their views in just over a month is significant.

ECB NIRP

A separate Reuters survey a few months ago asked what the chances were of the U.S. Federal Reserve deploying negative interest rates and got a response close to nil, as well as a particularly sharp critique from one economist: “Insanity may be contagious but I believe our Fed knows the long-term risks of such a policy.”

The immediate financial market impact of negative rates in some cases where they’ve been used was a rapid, short-lived fall in the currency, which theoretically at least, should have helped import inflation. But earlier this year in Japan, the opposite happened: the yen rallied.

The longer-term economic effect of the policy, which essentially charges banks to park funds with a central bank and instead encourages them to lend to businesses and consumers, is still unclear. Euro zone household credit growth, for example, was just 1.5 percent year-on-year in April, slightly lower than March.

Inflation has also failed to pick up in the almost 24 months since the ECB first cut the deposit rate to negative. A flash reading on Tuesday showed inflation was stuck at -0.1 percent in May.

Critics have pointed out that banks’ margins have eroded from having to pay interest on deposits to central banks while being unable to fully pass on those costs to customers, which would make little sense as a policy goal given an already widespread lack of demand.

Marius Gero Daheim, economist at SEB sums up the worry:

ECB policy is already counterproductive as banks are already rolling over the cost of negative rates to their retail customers, e.g. by raising transaction fees. Corporations are already starting to resort to hoarding cash rather than placing it with a bank at a negative rate.

The ECB’s Governing Council said in April:

Taking a broader view, on balance, the combination of all monetary policy measures taken, including negative rates, appeared to have contributed positively to banks’ profitability thus far.

But, it added:

A further cut in the deposit facility rate could unduly increase the pressure on banks’ profitability, which could have adverse effects on the stability of the banking sector.

So what is the floor on the negative ECB deposit rate before it becomes counterproductive? The latest Reuters poll suggested it was -0.50 percent, just 10 basis points lower than where it is now.

Deposit rate low

Few expect the ECB will cut its deposit rate any further from here, at least not until the end of next year — which is still a long way off.

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