Thanks, but where's the kitchen sink? The ECB and negative interest rates
The origin of the phrase “everything but the kitchen sink” goes back to the Second World War: so much metal was needed to fight the Nazis that households were encouraged to donate every metallic object in their homes – save for the porcelain in their kitchens.
Today, as the commemorations of D-Day began in Portsmouth and Ranville, Mario Draghi, President of the European Central Bank, has thrown everything but the kitchen sink at the Eurozone economy.
Mired in disinflation, threatened by deflation, plagued by sluggish growth, the Eurozone desperately needs an economic break. While the acute stage of the single currency’s existential crisis is now more or less over, all the continent’s chronic issues have come back to haunt it: dismal demographics, weak productivity, sclerotic regulatory systems. Add in the miserable recovery from the financial crisis, record unemployment (not forgetting hideous levels of youth unemployment) and, of course, the anti-EU vote in the latest European elections, and it was clear by this week that Something Had To Be Done.
Whether the Draghi plan is the appropriate “Something” remains to be seen. It consists, broadly speaking, of four parts. In descending order of interest/proximate importance:
1. Interest rates have been cut – the main refinancing rate from 0.25% to 0.15% and, most eye-catchingly, the deposit rate from zero to -0.1% (yes that’s a minus). That makes the ECB the first major central bank to experiment with negative interest rates.
2. There will be a new €400bn so-called Targeted Longer-Term Refinancing Operation (TLTRO) – a scheme whereby banks will be able to borrow long term (four-year) cheap cash from the ECB provided it lends out money to businesses, rather than sitting on it or spending it on government debt. This is very similar to the Bank of England’s Funding for Lending scheme.
3. The ECB will carry out “preparatory work on outright asset purchases” – aka the kind of Quantitative Easing the Bank of England and Federal Reserve have been doing for five years.
4. It will stop issuing bonds to offset the ones it bought through its emergency Securities Markets Programme. Though some are excited about this end to “sterilisation”, as it’s called, it’s less significant in the Eurozone than it would be elsewhere, due to peculiarities in the way their monetary system is structured.
The first thing to say about all of the above is that it is indeed significant. Draghi had come under fire in recent months for promising much (in the way of stimulus) but delivering little. He has finally come good, to an extent.
The negative interest rate had been broadly expected; the TLTROs were a bit of a surprise (though the hope was that there would be more).
Together, they amount to a carrot-and-stick approach, the objective being to encourage banks to lend cash out rather than hoarding it. The carrot is the cheap funding banks will get if they lend to businesses (the TLTROs); the stick is that they will be penalised for leaving their cash on deposit in the ECB’s coffers (the negative deposit rate).
The problem is that neither tool is exactly well-tested. A few central banks have experimented with negative interest rates – among them the Danes and the Swedes. Neither case has been a massive success. The Bank of England is very proud of its Funding for Lending scheme but it has enough detractors that one should hardly be overly optimistic about TLTRO’s chances either.
Most tellingly, investors – who greeted the initial set of announcements with sheer unadulterated joy – later moderated their feelings. The euro, which fell sharply upon news of the negative interest rate, later bounced back to close to where it started once Draghi had laid out the full details in his press conference.
It will take many months of data before we know whether the strategy is a success, and, indeed, Draghi added that the ECB’s plans were “not finished yet”.
However, it’s difficult to get escape the conclusion that the one thing markets didn’t get today – outright Eurozone quantitative easing – was the one thing they really wanted. QE is doubly tricky in the Eurozone, where there are countless legal obstacles, but if markets remain sceptical for much longer, Draghi and his colleagues may have to find a way of circumventing them.
Having thrown everything but the kitchen sink at investors today, it looks like the kitchen sink was precisely what they were after.