THE ECB PROMISES MUCH AND DELIVERS LITTLE / THE FINANCIAL TIMES COMMENT & ANALYSIS

June 5, 2014 2:47 pm

The ECB promises much and delivers little

By George Magnus

Negative deposit rates are novel but of questionable utility, writes George Magnus

©AFP

The European Central Bank has gone where no major central bank has gone before by cutting the interest rate it pays commercial banks on deposits from zero to minus 0.10 per cent. The cut was accompanied a comparable decline in its refinancing rate to 0.15 per cent, and by measures that the ECB hopes will boost lending in the euro area, including a €400bn long-term repurchase operation to be made available to banks in September and December.

Mario Draghi also announced that the ECB was working on a financing programme to purchase asset-backed securities, but there is so far no suggestion that the ECB will be buying government bonds – as the central banks of the US, UK and Japan have done.

Two immediate questions spring to mind. Why has the ECB decided to deploy more monetary weapons? And, will they be effective?

The ECB’s hand has been forced by the eurozone’s sluggish economic recovery, which is so feeble that it is proving hard to shrug off deflationary effects. In May the regional consumer price index rose by just 0.5 per cent over a year ago. But that aggregate figure, already well below the ECB’s target of about 2 per cent, masks lower rates in many countries. Some have even experienced falling prices. Excessively low inflation threatens to make the sustainability of sovereign debt an impossible challenge.

Negative deposit rates are the novel part of the package, but their effectiveness is questionable. European banks’ deposits at the ECB have fallen close to zero in the past several months, and their reserve holdings at the ECB, to which negative rates will also apply, have also diminished significantly. The negative interest rate, therefore, is unlikely to have a significant effect on banks’ behaviour. The LTRO facility might help at the margin to boost lending to the private sector. But regulations are forcing banks to shrink their balance sheets. Many lenders have amassed huge holdings of government bonds. And loan demand by companies is weak anyway.

In time the asset-backed bond purchases might, if they are large enough, help to re-energise European corporate debt markets. Full quantitative easing, which would entail purchases of government bonds, still seems a long way off, and it might not happen unless there is a renewed bout of financial turbulence. The ECB has acquired a reputation for promising much and then underwhelming on delivery. It has now gone a little further than in the past. But is unlikely to be enough to stir banks to lend more, nor to weaken the euro by enough to arrest deflation.

Copyright The Financial Times Limited 2014.