Investors in Europe about to enjoy historic plunge to negative interest rates
Imagine having $2000.00 in your bank account. The next time you check its $1996.00
Banks typically make money on the cash they park at a central bank. Now the European Central Bank wants them to pay for the privilege.
The move, a so-called negative interest rate, is part of a wide-ranging set of measures aimed at combating the crippling combination of slow growth and superlow inflation.
The initiatives, announced on Thursday by the European Central Bank, include the usual fare — interest rate cuts and cheap bank loans. But the bank also showed a willingness to test new tools like the negative interest rate, in a nod to just how worrisome the economic situation has become in Europe.
Taken collectively, the measures send a strong message to investors, businesses, and citizens that the central bank is determined to put Europe on a path to stronger growth.
The bank president, Mario Draghi, also signaled that he was prepared to go further if necessary. In doing so, he left the door open to employ the same powerful, albeit controversial, bond-buying program that was used to restart growth in the United States.
Euro Zone Cuts Rate
The European Central Bank cut its benchmark interest rate on Thursday, while the Bank of England left its main rate unchanged.
“We think this is a significant package,” Mr. Draghi said on Thursday at a news conference. “Are we finished? The answer is no.”
With European political leaders struggling to address the region’s economic woes, the central bank is aggressively moving to prevent the region from lapsing into the same sort of stagnation that has long afflicted Japan. Just this week, there was news that inflation in the euro zone had fallen to a mere 0.5 percent for the year ended in May, well below the bank’s target of around 2 percent.
Even without outright deflation, it is a perilous trend that can cause people to delay purchases and can undercut corporate profit and job creation. The central bank’s staff expects inflation to return to 1.1 percent in 2015 and 1.4 percent in 2016.
The bank is taking a broad tack in its efforts.
The central bank cut its benchmark interest rate on Thursday to 0.15 percent, a record low, and said it would offer banks cheap four-year loans — with strings attached to make sure they lend the money to businesses.
In addition, the central bank said it was moving closer to making purchases of packages of business loans, another way of funneling credit to companies in troubled countries like Greece that desperately need it.
And many economists wonder whether the central bank is doing enough, given the current economic picture. The central bank stopped short of using its metaphorical bazooka, the large-scale purchases of bonds and other financial assets known as quantitative easing.
“The conventional measures are all done,” said Guntram B. Wolff, director of Bruegel, a research organization in Brussels. “What remains is quantitative easing.”
While Denmark and Sweden have experimented with negative interest rates, the ECB is the first major central bank to do so. Although rates in Canada and the U.S. have been described as “having nowhere to go but up” in recent years, Europe’s decision potentially suggests otherwise.
This is a modern day experiment in central banking to discourage banks from hoarding cash. One of the key intentions of the rate move is to encourage bank lending, which would have a resulting impact on spending, economic growth and inflation.
Borrowers have got to wonder if low rates are here to stay or if they could get lower. Maybe 2.99%, 5-year fixed rate mortgages aren’t such a good deal after all? If rates are falling elsewhere, why not here?
The other side of the coin is to consider the fact that the ECB has lowered rates because they’re concerned about deflation, a decrease in prices where inflation actually goes negative. Deflation increases the real value of debt, making it harder to pay back debt when prices, incomes and asset values are declining. And given the precariously high debt levels of some key countries, deflation could be particularly difficult if it ever came home to roost.
“The conventional measures are all done,” said Guntram B. Wolff, director of Bruegel, a research organization in Brussels. “What remains is quantitative easing.”
If only pigs could fly, but clearly they dont!
Sources
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