Today, the European Central Bank announced that they were
reducing interest rates, and adding several other banking measures
designed to increase bank lending, in order to better assist the
euro zone's economic recovery.
The ECB decreased their lending rate from 0.25% (introduced in
November 2013) to 0.15%, but more importantly, the ECB also
decreased their rate on overnight bank deposits with the central
bank to -0.1%. Finally, the rate cuts also included a
reduction in emergency overnight loans as well.
The negative overnight bank deposits change is essentially
charging commercial banks to keep their money with the ECB, a very
unusual move by the central bank. Moreover, the ECB
President, Mario Draghi, stated that the "new interest rates would
remain low for a considerable period of time, and possibly for
longer than previously seen."
Goal of the ECB
These new measures are designed to spur bank lending, and to
battle low inflation levels within the European Union. The
plan is that banks will begin to lend some of their excess cash to
other banks as loans (instead of being penalized by the -0.1% bank
deposit fee), which the ECB hopes will then flow into the euro-zone
economy. The EU utilizes this lending to fund investments and
overall hiring. This negative deposit rate has been attempted
before, by the likes of Denmark and Sweden, but the end results
have been mixed.
One of the major issues caused by this decreasing inflation is
that consumers see falling prices, and then put off making big
purchases due to the fact they believe prices are going to continue
to drop, therefore exasperating the overall issue by weakening
growth levels even more.
Therefore, this change by the ECB, is designed to decease the
value of the Euro, which would increase exports (read cheaper items
for the international market coming from the EU), and increase
inflation which causes imported goods to cost more.
Essentially, the ECB is importing inflation to their Union member
How the ECB Move is Viewed
Previous attempts to curb the very low inflation, have been
criticized as not being enough, or have not been successful in
curbing the decreasing inflation numbers. Moreover,
analysts believe that it will take several months, if not a year,
for the change of interest rates to trickle through the
After this change today, Mr. Draghi stated that he and his team
were prepared to increase the measures to increase inflation, if
this most recent measure was not enough. He went on to say,
that the ECB would consider implementing a large scale asset
purchase, similarly done by the US Federal Reserve.
If this most recent move is proven to be successful, it will be
a boon for companies that both import items to the EU, and
companies that export items from the EU. This would be great
news for American based companies with a strong presence in Europe,
) to name a few.
On the negative, the decreased rates might not impact bank's
bottom lines enough to take the risk of the -0.1%, verse the
underlying loans; thereby the banks would not spur lending, but
rather continue to hold onto the cash. This would cause the
ECB to further attempt to curb declining inflation by decreasing
their interest rates even further (not that there is much more room
to go), and or implementing a Quantitative Easing program.
This will face a headwind from Germany, who is staunchly against
any form of QE.
Another outcome is that the FX value of the Euro does not
decline as expected (what the market is currently witnessing today)
causing the opposite intended effect. If the value of the
Euro continues to increase, it will make exported items more
expensive, and imported items less expense, essentially exporting
more inflation and importing deflation to the EU. This would
force the ECB into more drastic measures (read QE). Moreover,
it would negatively impact American companies with a large presence
in Europe, like
) to name a few.
Even with these drastic measures, stopping the declining
inflation might not be a certainty, and it will take many months to
decipher any measureable impact by the new rules.
Nevertheless, it is encouraging to see the ECB make more aggressive
steps in curbing the decline, and monitoring the situation as a
whole. Moreover, the ECB has not yet run out of economic
tools to further implement their anti-inflation programs.
We are all now at a wait and see moment in time.
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