Negative Interest Rate Skepticism Grows at the European Central Bank

Commercial banks have long squealed about negative rates which directly curtail profits by imposing a charge on cash reserves.

01 Nov 2019, 10:54 AM IST

Negative Interest Rate Skepticism Grows at the European Central Bank

The European Central Bank (ECB) logo is seen during the bank’s news conference in Frankfurt, Germany. (Photographer: Hannelore Foerster/Bloomberg)

(Bloomberg) --

One of Christine Lagarde’s most important tools for stimulating inflation might be falling out of favor even before she gets to wield it as European Central Bank president.

Doubts over negative interest rates are beginning to surface among policy makers on the continent where they first appeared half a decade ago. A growing contingent of officials at the ECB in Frankfurt are starting to wonder if they cause more harm than good, and Sweden’s Riksbank seems desperate to be rid of them altogether.

Commercial banks have long squealed about negative rates, which directly curtail profits by imposing a charge on their cash reserves, and the cries are getting louder. But it’s the shifting mood among monetary officials and the fact that inflation has stayed stubbornly low that suggests the strategy may be running out of steam.

“Opposition to the negative deposit rate is increasingly becoming widespread,” said Gilles Moec, chief economist at Axa SA in London. “You could be a dove and still believe that negative rates are not great.”

The prospect that the strategy might not be worth the pain it causes is alarming for officials because they already have such a limited toolbox, with quantitative easing also getting close to the boundaries of what it can do. Lagarde’s reign could be blighted by policy impotence right from the start.

While U.S. President Donald Trump repeatedly slams the Federal Reserve for not copying the policy, even the staunchest European defenders accept that they now need to deal with the side effects.

When outgoing President Mario Draghi cut the ECB’s deposit rate to minus 0.5% in September as part of a final package to bolster the economy against global trade tensions, he included an exemption for banks from some of the cost. The Swiss National Bank, which along with the Danish central bank has the world’s lowest policy rate at minus 0.75%, stepped up its relief for lenders.

Relatively hawkish officials such as Bundesbank President Jens Weidmann and Dutch central-bank governor Klaas Knot have often warned that ultra-low rates blow up asset-price bubbles and encourage risky leveraged loans. Such concerns are included in the ECB’s own Financial Stability Review. Belgian Governor Pierre Wunsch told Bloomberg this month that officials may need an escape clause from their pledge to keep rates at present or lower levels.

Even Bank of Italy Governor Ignazio Visco, a longtime supporter of monetary stimulus, is reluctant to back any more cuts, saying on Thursday that there’s “uncertainty” over the effectiveness of some of the ECB’s stimulus measures. Vice President Luis De Guindos said the negative side effects have become “increasingly significant.”

Austrian governor Robert Holzmann wants the ECB to start a discussion under Lagarde on reversing the negative-rate policy in a way that “won’t play havoc.” She might be willing, telling France’s BFM TV on Wednesday that “there is a moment when the question will need to be asked of the balance between the positive and negative effects” of negative rates.

The Riksbank is already on that path. Swedish officials surprised most economists and traders this month by explicitly pointing to a hike in December that would bring the repo rate to 0%. Governor Stefan Ingves said negative rates have worked well but “many people think they are strange.”

The strangeness is an important part of the problem. Central bankers used to be worried that if they cut rates below zero then companies and savers, averse to losing money yet unwilling to make riskier investments for a slightly higher return, would hoard banknotes.

That hasn’t happened on any significant scale, but it’s also clear that many people simply don’t like the policy. Those preparing for retirement resent getting no return on their savings, and fears are growing that banks will make them share the cost. Some wealthier customers are already being charged.

“The key issue really lies outside monetary policy,” said Moec. “If this situation with negative rates continues, it can end up triggering a backlash against the central bank.”

Now sub-zero rates are in place though, exiting them won’t be easy. In fact, investors price a 60% chance of another ECB cut by October next year. The Bank of Japan, which also has negative rates, changed its policy language on Thursday to open room for further cuts there.

Draghi says the fastest way to exit the policy is for governments to help out with structural reforms and fiscal support. Norway has shown how that can work -- public spending allowed the central bank to raise rates four times in the past year and its benchmark now stands at 1.5%. Draghi is fond of citing the U.S., where fiscal measures and deeper capital markets allowed the Fed to escape its crisis-era settings.

There’s been little sign of such developments in the 19-nation euro zone though. Germany, the largest economy, is reluctant to end its budget surpluses despite a manufacturing slump, and a common budget agreed by the currency bloc this year will amount to just 20 billion euros ($22 billion), or 0.2% of GDP. That way of thinking may have to change.

“Clearly policy makers will look at a broader toolbox,” Nick Nelson, UBS head of European equity strategy, told Bloomberg Television. “We are getting toward the end of where we can go with negative rates.”