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The European Central Bank is approaching the point where it needs to decide whether if negative interest rates are more problem than solution.
Since officials pushed back plans to tighten policy, warnings have increased that the potency of a key instrument used to rekindle growth in the 19-nation bloc is diminishing the longer it remains in place. France’s Francois Villeroy de Galhau, formerly of BNP Paribas SA, is loudest in voicing concern that sub-zero rates may prevent stimulus from reaching the economy because they’re hurting bank profitability.
The argument isn’t unique to Europe. Banks in Japan are urging policy makers to watch that negative interest rates aren’t causing side effects, and officials at the Federal Reserve, which has never used the measure, argue it could cause problems for the U.S. financial system.
In the eyes of ECB President Mario Draghi, sub-zero rates “have been quite successful” -- reason enough to examine whether mitigating measures may be needed to ensure they remain a worthwhile tool.
Fueling the debate is an academic concept that describes how at some point low borrowing costs start to harm rather than help the economy. The euro area may be on the cusp of it, according to Markus Brunnermeier, an economics professor at Princeton, who pioneered the idea of the reversal rate.
“Going negative was not a bad choice for the ECB,” he said in an interview. “But you have to figure out how long you want to stay low because the reversal rate tends to creep up and you may need measures to slow it down.”
While Brunnermeier isn’t advocating a rate increase, he argues that policy makers could consider following Switzerland’s example, where only reserves above a certain level are penalized.
Since the ECB cut its deposit rate below zero in June 2014, banks have had to pay to park money at the central bank, and growing amounts of liquidity in the financial system as a result of large-scale asset purchases and long-term loans increased the cost. With lenders struggling to pass on those charges to their clients, they’ve eaten into profit margins.
What Bloomberg’s Economists Say
“The Governing Council doesn’t seem to be overly concerned about the impact of its negative-rate policy on banks. In any case, the problem should soon be resolved -- we expect the ECB to start raising the deposit rate in March 2020 and bring it to zero by September.”
David Powell, senior euro-area economist
Deutsche Bank AG economist David Folkerts-Landau estimates euro-area lenders lost about 8 billion euros ($9 billion) a year to the policy, and S&P Global Ratings has warned that the delay in raising rates will weigh negatively on banks’ credit ratings and force them to seek extra cost cuts.
“Europe needs monetary stimulus and negative rates are providing that,” said Isabelle Mateos y Lago, chief multi-asset strategist at BlackRock Investment Institute. The onus is on governments and regulators to come up with ways to alleviate the burden.
So far, the ECB has cushioned the effect by offering to pay banks for lending to companies and households. A new batch of loans due to be rolled out in September will probably be less attractive, while increasing already excessive amounts of liquidity.
For Peter Chatwell, head of European rates strategy at Mizuho International in London, that’s a signal bank profitability will be harmed for a longer period. To provide at least some relief, he argues, policy makers could restart bond purchases or extend the maturity of assets already on its balance sheet.
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