Retail Latin America: The Era Of Negative Interest Rates Has Begun

MAMTA BADKAR

In a bid to counter weak growth and prevent deflation, European Central Bank chief Mario Draghi has lowered main interest rates.

Specifically, the ECB cut the deposit rate to -0.1%, from 0.0%, effective June 11.

This is a historic development, as it's the first time a major central bank has cut any main interest rate to negative in a bid to spur lending and spending.

The idea is that if banks aren't being rewarded with a good deposit rate by parking their reserves at the central bank, then they will be more likely to lend it to households and businesses.

During his press conference, Draghi pointed out that "the rates we've changed are for the banks, not for the people. …It's wrong to think we want to "expropriate savers." But he said the decision to lower rates for households would have to come from the banks not the ECB.

The refinancing rate was lowered by 10 basis points to 0.15%, which was a slight disappointment.

Finally, the marginal facility interest rate was lowered by 35 basis points to 0.4%. This is the rate that banks pay to borrow from the central bank.

In the press conference that followed the announcement, Draghi unveiled longer term refinancing operations (TLTROs).

"What is in this TLTRO that makes it different?" said Draghi during the press conference. "The cost obviously, it is very low, the term maturity is four years, and the termination that this money not be spent on sovereigns and on sectors that are already experienced or have just come out of a bubbly situation, that's what in it."

He also added that the ECB would suspend its weekly securities market program (SMP) sterilization, which frees up €165 billion in liquidity.

These cuts were largely priced in so markets moved modestly higher in response to the news but the Dragi effect work off soon after the press conference ended.

"A negative deposit rate is bearish for the euro in the short term, but we need more detail on exactly how this new interest rate regime will be implemented to gauge the full effect," Claus Vistesen at Pantheon Macroeconomics wrote in an email after the release.

The last central bank to push rates into negative territory was the Danish central bank. Richard Milne at the Financial Times explains the difference between the two central banks:

The first thing to note is that the ECB’s justification for such a move will be different from the Nationalbanken’s. Denmark’s monetary policy is aimed at maintaining the krone’s currency peg with the euro. Denmark introduced negative rates to stem massive inflows from investors looking for a safe haven outside the eurozone that was causing the krone to strengthen.

The ECB, by contrast, has an inflation target. Last month, Mario Draghi, ECB president, said rate-setters were “comfortable with acting next time” because there was “dissatisfaction about the projected path of inflation”. While the ECB is primarily concerned with prices, the strength of the currency also matters: Mr Draghi has often said the strong euro is one of the most important reasons why inflation is so low as this has made imports cheaper

Draghi announced a three-step response to counter weakness in the eurozone at an ECB forum earlier this month. "The first step involves a reduction in interest rates to put downward pressure on rising money market rates, and to depress the exchange rate," Vistesen wrote ahead of the announcement. These are the cuts we just got.

"The second step responds to sluggish credit growth by targeting lending to non-financial corporates through either an LTRO or private QE," writes Vistesen. "The final step sees a broad-based asset purchase program to counter a persistent lurch lower in inflation expectations."

Here's the full decision:

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.15%, starting from the operation to be settled on 11 June 2014.

The interest rate on the marginal lending facility will be decreased by 35 basis points to 0.40%, with effect from 11 June 2014.

The interest rate on the deposit facility will be decreased by 10 basis points to -0.10%, with effect from 11 June 2014. A separate press release to be published at 3.30 p.m. CET today will provide details on the implementation of the negative deposit facility rate.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today. Further monetary policy measures to enhance the functioning of the monetary policy transmission mechanism will be communicated in a press release to be published at 3.30 p.m. CET today.

And here's a nice cheat sheet from Bloomberg eurozone economist Maxime Sbaihi: