adminSTOCKHOLM — With its decision yesterday to introduce a negative bank deposit rate the European Central Bank has become the first major central bank to experiment with a mechanism pioneered in Scandinavia. The ECB announced it will lower its overnight deposit rate from zero, where it has been since July 2012 to -0.1 percent.
This is the rate at which commercial banks are paid, or will now be paying, to place funds at the central bank.
Thus a commercial bank which deposits one million euros with the central bank will now see its funds eroded to 999,000 the day after.
The rate is a secondary monetary policy instrument for the Frankfurt-based institution and the sums involved are minimal with only 36 billion euros ($40 billion) held in the deposit facility today compared to 800 billion euros in early 2012.
In theory, dropping the rate below zero should boost the European economy by encouraging banks to cut the amount of funds they park at the ECB and put the money to work in the economy.
However, analysts question whether it works in practice, given the inconclusive results of using negative deposit rates by the central banks of Sweden and Denmark.
Bruno Cavalier, an economist at Oddo Securities said the Scandinavian banks were “second tier central banks” whose influence could not be compared to that of the ECB.
“The ECB will be the first major central bank wandering into negative territory,” according to economists at the Swedish bank Nordea.
Sweden — with a central bank which has shown it is not afraid of exceptional measures (such as a main interest rate of 500 percent in 1992) —pioneered the negative rate approach.
Between July 2009 and September 2010 interest rates on deposits were set at -0.25 percent in order to break the spiral between the financial crisis and looming recession.
While the sums involved were low, the symbolic nature of the move was significant as it was the first time it had been tried — not even Japan dared to bring in negative rates in the depths of its worst deflationary period.
“Negative interest rates fascinate both professional economists and the public,” Yang Liu, a researcher at the US Federal Reserve, said in 2013.
“Although the rate attracted media attention, it meant nothing because banks historically have placed only very small amounts in term deposits.”
Denmark followed the Swedish example from July 2012 to April 2014 (with -0.2 percent and then -0.1 percent) but it was a special case: its central bank is tasked with keeping a stable exchange rate to the euro.
According to the bank’s own evaluation the policy was a success from the exchange rate perspective and had a “clear” influence on lowering interest rates on money markets, despite having a limited effect on the overall economy.
And the ECB move also aims to influence exchange rates.
If banks are discouraged from depositing their euros with the ECB, and they don’t want to increase lending to businesses as policymakers would like, they might sell them in order to place capital elsewhere, thereby lowering the value of the single European currency.
But economists at the US bank Citigroup said the new rate should succeed “moderately”, given that the exchange markets had already priced in the change. — AFP
derick.khumalo