Negative Interest The ECB’s Bitter Medicine

The financial sector and savers around Europe face further pain from the European Central Bank, which may lower its negative deposit rate even further at its March 10 meeting.
Mario Draghi's ECB is hurting banks and savers in the euro zone. That may be hurting the overall economy too.

Like most of the world’s central bankers, Mario Draghi’s job is clearly defined: The European Central Bank president must make sure that consumer prices in the 19-nation zone rise just under 2 percent each year over the medium term.

That's not as easy at it may sound. The ECB has come up short for three years now. In February, euro zone consumer prices even fell by 0.2 percent from a year earlier, dragged down by falling energy prices.

Mr. Draghi’s miracle cure for low inflation – a €1.2-trillion, or $1.3-trillion, bond purchase program launched just over one year ago – also doesn’t appear to be working. The February price decline was bigger than at any time since the ECB started its quantitative easing plan last March.

The weak price gains have put Mr. Draghi under pressure ahead of the ECB’s next policy-setting meeting on March 10. The biggest problem is that he’s running out options to boost prices.

Not only that, but the actions he has taken seem to be hurting rather than benefitting key sectors of Europe’s economy.

Banks, savers, pensioners and insurers are suffering under the ECB’s desperate efforts to get financial firms to take bigger risks and lend money.

The banks have to cope with declining interest margins. Many are taking substantial risks to achieve acceptable interest margins. Clemens Fuest, President, ZEW Think-Tank

Whatever the result, one can't accuse the ECB of inaction.

In December, the governing council raised its charge on banks that park money at the ECB, doubling down on a measure that was unprecedented before the 2008 financial crisis. The deposit rate, which in normal times offers banks interest on their excess reserves, was cut to -0.3 percent from -0.2 percent.

The ECB was already the only major global central bank to push the rate into negative territory, effecting penalizing banks for parking money instead of lending it out and kick-starting Europe's stagnant economy.

But Europe's economy remains stuck largely in idle, while the negative interest rates are hurting banks' bottom lines. Rather than boosting lending, many banks have simply passed along the ECB's penalties to their customers.

U.S. investor Warren Buffett recently said: “We would be better off with a big mattress in Europe that we just stick all this stuff in, if I could just find a person I trusted to sleep on that mattress. It distorts everything.”

So far, banks have refrained from making private customers pay for depositing money. But they’re already charging investment funds and small businesses.


Negative Yields-01 bonds treasuries money market


Increasingly, small and mid-sized businesses are being asked to pay punitive interest rates to park their money overnight – just like banks do at the ECB. The average rate for overnight deposits at banks is well below 1 percent.

Günther Bessinger, the managing shareholder of engineering firm MN Maschinenbau Niederwürschnitz, said firms were being charged for revolving credit facilities even when they’re not drawing on them. “That’s a disastrous signal for confidence in the banking sector in Germany,” he said.

Barkow Consulting, an advisory firm, estimated that the ECB's December cut in the deposit rate will cost banks €1.4 billion per year if they don’t cut their own overnight deposit rates for private and business clients even further.

To make matters worse, almost 80 percent of German sovereign bonds are no longer yielding any interest. European sovereign bonds worth €3.3 trillion are paying no interest.

Effectively, investors lending money to euro-zone countries are charged a kind of parking fee for the privilege of putting their money in supposedly safe assets. It’s good news for finance ministers because it means they can actually earn money by borrowing.

But the sharp declines in German and European banking stocks this year stem in part from the impact of negative interest rates on the financial sector.

“The banks have to cope with declining interest margins. Many are taking substantial risks to achieve acceptable interest margins,” said Clemens Fuest, the president of German think tank ZEW.



Insurers are being hit just as hard.

The German Insurance Association GDV has calculated that German insurers earned €15 billion less from 2008 through 2013 from low interest rates. Interest rates weren’t even negative during that period, suggesting more pain is on the way. Negative rates are particularly bad for insurers because they invest much of their premium income in bonds.

Oliver Bäte, the chief executive of Allianz, Germany's largest insurer, said consumers would have to “dramatically increase their savings” to achieve the same level of pension payouts — or invest money in higher-risk assets.

Germany’s state-run social insurance funds are also affected because they have to pay to deposit money at banks. The interest paid to banks by statutory health insurers was €1.8 billion last year. That’s not a huge amount given the total asset volume of €200 billion, but it’s the principle that counts, said insurers.

Welfare contributions shouldn’t be charged any interest at all, said Franz Knieps, head of the Betriebskrankenkassen, the organisation of 87 company-linked health insurance funds.

Real estate investment funds are also suffering because they have to hold between 20 and 25 percent of their volume in cash or short-term paper so that they can repay investors who want to withdraw their funds.

“If the ECB cuts the deposit rate even more, the negative yields will feed through even further,” said Frank Engels, head of fixed income fund management at Union Investment.

Meanwhile, the market's expectations for inflation in the euro zone continue to fall, pushing Mr. Draghi's ECB to act.

“There are no limits to how far we are willing to deploy our (monetary) instruments,” Mr. Draghi said in January.


Low Inflation Expectations-01 euro zone


That means rates look set to slip deeper into negative territory, though some changes to ease the pressure on banks may be on the way.

The ECB might also decide on a staggered deposit rate regime similar to one used in Switzerland where a negative rate kicks in only when a bank’s excess liquidity exceeds a threshold. That goes easier on a bank’s finances but also provides less incentive to increase lending.

Alternatively, the ECB could expand its bond-buying from the current €60 billion a month. That would be hard on the Bundesbank, the German central bank. A further decline in the deposit rate would be the lesser evil as far as the Bundesbank is concerned.

But that’s academic. Bundesbank President Jens Weidmann, who has been a vocal critic of the the ECB’s quantitative easing program, won’t be allowed to vote on March 10. That’s because the voting system at the ECB changed with Lithuania's adoption of the euro in 2015, meaning that national central bank governors are now divided into groups of smaller and larger economies to ensure efficient decision making.

The five largest economies with the biggest financial sectors will share four votes. These are Germany, France, Italy, Spain and the Netherlands. Under a new rotation system, the Bundesbank will have no voting power once every five months.

Financial sources said Mr. Weidmann’s enforced abstinence suits Mr. Draghi. But it won’t have any impact on the outcome because the heads of the Irish, Estonian and Greek central banks won’t get to vote either.

Irish bank chief Philip Lane and his Greek colleague Yannis Stournaras are regarded as policy doves against the two hawks, Mr. Weidmann and Ardo Hansson of Estonia. So two doves and two hawks will be left out of the voting.

Andrea Cünnen and Jan Mallien are editors at Handelsblatt who write about finance and central bank policy, among other subjects. To reach them: [email protected] and [email protected]