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 countries.
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 economy.
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, like, Manpowergroup (MAN - Analyst Report) , General Electric (GE - Analyst Report) , Honeywell (HON - Analyst Report) , and 3M (MMM - Analyst Report) 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 Manpowergroup (MAN - Analyst Report) , General Electric (GE - Analyst Report) , Honeywell (HON - Analyst Report) , and 3M (MMM - Analyst Report) 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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