News Column

Europe weighs risks of negative interest rates

June 2, 2014

DAVID McHUGH, AP Business Writer



FRANKFURT, Germany (AP) The European Central Bank could be going negative soon.

Among the more unusual steps the central bank is considering this week to boost the eurozone's recovery is cutting to below zero the interest rate it pays on money that banks deposit with it. That effectively means banks would have to pay to park money with the ECB an unorthodox move that has had some success in neighboring Denmark but hasn't been attempted in the much larger eurozone.

The goal: Push banks to lend that money to companies and consumers to get the economy moving.

The ECB, the eurozone's chief monetary authority, has been resisting such a step, which it considered as long ago as summer 2012 but which President Mario Draghi dismissed then as "largely uncharted waters."

But things are now bad enough that many analysts think Draghi and the 23 other members of the ECB's governing council will try the step Thursday and cut the deposit rate from its current record low of zero, perhaps with a rate of minus 0.1 percent. The ECB is also expected to trim its main interest rate, at which it lends to banks, from 0.25 percent to as low as 0.1 percent.

Slow lending has been holding back the eurozone's economic rebound from its financial crisis. Banks are harboring too many bad loans and, fearful of taking new risks, are not lending to consumers and businesses at the low rates the ECB has set.

So taxing banks, in effect, for hoarding money at the ECB's super-safe deposit facility, could get some of that money moving into the economy instead or so the thinking goes.

Just as important, a negative rate could push down the exchange rate of the shared euro currency.

By lowering the cost of imports, the strong euro has helped push inflation to only 0.7 percent so low it has raised concerns the fledgling recovery will slide into deflation, a crippling condition for the economy in which consumers put off purchases in hopes of better deals. The currency has eased to $1.37 from a 2 year high just under $1.40 in the three weeks since Draghi strongly hinted stimulus measures were coming.

Including a cut to the ECB's benchmark interest rate, "the combination could prove a powerful cocktail that boosts bank lending," said Christian Schulz at Berenberg bank.

"But negative deposit rates have not been used at this scale before and could have unpredictable consequences."

In smaller economies, however, negative rates are not unheard of.

On a much smaller scale, Denmark's central bank went with a negative deposit rate of 0.2 percent from July 2012 to April this year. Sweden's central bank tried it in 2009-2010.

It had little effect in Sweden, but in Denmark, it capped an unwanted rise in the country's krone currency, which it tries to keep stable against that of its neighbor, the eurozone.

The negative deposit rate accomplished that by pushing down market rates on fixed-income investments such as bonds denominated in kroner. That discouraged investors from pouring their money into Danish holdings, which at the time were perceived as safer amid fears the eurozone might break up.

Yet it wasn't pain-free.

Reluctant to lend more, and unable to lower the already rock-bottom rates they paid their own depositors, Danish banks swallowed an estimated 50 billion euros ($68 billion today) in losses, or about 2 percent of their earnings for 2013, according to the Danish Banking Association.

Another risk with negative rates is that banks simply pass the costs on to customers through new fees or higher loan rates. Lending rates were little changed in Denmark.

And lending to the corporate sector actually declined slightly during the negative-rate period in Denmark.

Helge Pedersen, chief economist at Nordea Bank, said that, on the whole, the negative rate worked for Denmark. But it may not be as easy for the eurozone, which is struggling to shape up shaky banks that would find the cost an added burden on repairing their finances.

"It can achieve the objective of weakening the euro," Pedersen said. The weaker currency could help exporters in an economy that grew just 0.2 percent, quarter-on-quarter, in the first three months of the year.

"But from a purely banking perspective it is a dramatic step to take. It can have quite a negative effect on a bank's earnings prospects," Pedersen said.

"The European Central Bank also has to take care for financial stability, and this to my mind is not helping financial stability."


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Source: Associated Press


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