The ECB steps into the world of negative rates but will it help the real economy?

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Today is the morning after the night before for the European Central Bank which yesterday made a move I forecast some time ago. It was back on the 2nd of September 2011 that I posed these questions.

Negative interest rates have failed to halt the rise of the Swiss Franc but will they spread to us anyway?

Will negative interest rates spread world wide?

In the meantime it became ever plainer that of the major central banks, the ECB was the most likely to take this step with an occasional hint from Japan. The Swiss situation was different in that it saw negative interest-rates for some of its bond yields and also on some retail bank accounts, whereas the ECB is for now imposing it essentially on banks which deposit with it. However there are clear similarities.

The exchange rate

There are clear parallels here and Mario Draghi and his colleagues on the ECB Governing Council must have been very disappointed when the Euro’s decline after their various announcements yesterday was so short. When I pointed this out on twitter the economist Edward Hugh replied that it lasted one hour and fifty-seven minutes only. As I type this the Euro is back in the mid 1.36s versus the US Dollar which is pretty much unchanged on yesterday morning. So the experience here is very similar to that of the Swiss Franc where neither falling nor negative interest-rates helped to weaken the currency very little if at all.

As the exchange rate is perhaps the most powerful monetary tool available these days then if this experience continues we are already downgrading the possible economic impact of yesterday’s moves. As I pointed out on Tuesday we should not be surprised by this as we had already seen 4% of interest-rate reductions before yesterday’s additional 0.1%.

Trade surplus

Whilst currencies do not always follow a path you might expect from their countries trade figures some do. This morning has seen yet another current account surplus announced for the Euro area which totalled 18.8 billion Euros in March. In fact this is nothing new and all three parts (trade, services, income account) were in surplus. So the value of the Euro will be supported by this which is happening month after month.

Equity markets

These surged across Europe with particular headlines being created by the fact that the German Dax pushed though 10,000 for the first time. Some of the eu(ro)phoria waned but stock markets are higher overall. Those who think that this is the main aim of central banks these days will no doubt be having a wry smile right now. As to the economic effects of this on the real economy we have discovered to our cost that they are very weak.

Bond markets

These surged too in response to the news. The “core” market which is of course the German Bund saw rallies and its ten-year yield is now only 1.38%. The two-year yield has fallen to 0.03% and may yet venture again into the world of negative yields itself. The periphery saw gains too with the Spanish ten-year yield for example dropping to a record 2.76% this morning. It is now only 0.1% higher than the equivalent UK Gilt and that relationship or spread has come in massively over the past 12/18 months.

So if this continues there will be gains for many Euro nations in that they will be able to issue their debt more cheaply.

What about the real economy?

I have written many times before about the apparent divorce between the financial and real economies in the credit crunch era. We see that some financial markets have improved but what about the real economy? As the dip into negative interest-rates was mostly a technical one affecting money markets and banks we are left reviewing a 0.1% cut. What next a 0.01% one? Anyway in these times of broken monetary transmission mechanisms the rate cut is unlikely to have anything other than a minor effect which I am not absolutely sure will be positive. So let us examine the other measures which come under the category of extraordinary monetary measures. After all we are at this point let rather short of the “everything it takes” promise by Mario Draghi back in 2012 especially as he clearly said at one point this was as far as the ECB was willing to go on interest-rates. That may well be an outright falsehood but he was quite clear about it in the press conference.

Targeted LTROs

This to my mind was initially rather awkward as whilst the use of targeted was no doubt meant to sound impressive it also suggested that the previous 2 LTROs were not targeted. Ooops!As some 1.018 billion Euros of liquidity was provided by them there is an implication here that they could have been better designed. Also the total size of the new effort was estimated at a smaller 400 billion Euros.

Counterparties will be entitled to an initial TLTRO borrowing allowance (initial allowance) equal to 7% of the total amount of their loans to the euro area non-financial private sector, excluding loans to households for house purchase, outstanding on 30 April 2014. In two successive TLTROs to be conducted in September and December 2014, counterparties will be able to borrow an amount that cumulatively does not exceed this initial allowance.

The interest rate on the TLTROs will be fixed over the life of each operation at the rate on the Eurosystem’s main refinancing operations (MROs) prevailing at the time of take-up, plus a fixed spread of 10 basis points.

So they specifically exclude the housing market and would currently cost 0.25% per annum. At this point if you consider imitation to be the sincerest form of flattery than the Bank of England should be very flattered right now as it observes the similarities to its Funding for Lending Scheme. However that similarity also poses its own problem as it has so far failed to do much about lending to small businesses in the UK and continued to fall. Defenders of the policy have been reduced to using that old chestnut the counterfactual by saying the situation would have been worse without it. That is conveniently unproveable of course.

Also the areas that really need help from this seem the least likely to use it as places like Italy have plenty of bad debts for example which have been hindering lending. So there is no clear cut gain here either.

Securities Markets Programme

The SMP is the place where the ECB holds the peripheral debt bought at the height of the crisis. Each week it issues debt itself to suck up the liquidity it provided from this. It calls this “sterilisation” but I do not believe that it is. Going forwards that will matter less as it will stop the sterilisation, although to some extent this is only acknowledging reality as in recent weeks it has struggled to cover the full amount. So around 164.5 billion Euros of extra liquidity will be around in the short-dated money markets. So helpful for them but probably not that much help for the real economy.

Asset Backed Securities

This section was rather like the bit in the film Field of Dreams where we are told “build it and they will come”. Mario Draghi would like markets to create an ABS market so that the ECB can buy some of it. I know that this sounds like a spoof as so much does these days but it is true! Imagine the potential hazards and traps awaiting the ECB as it steps into a pack of wolves and buys “AAA-rated securities”. What could go wrong?

An example of how this could go wrong was illustrated by the way that what was supposed to be top quality paper (debt) deposited at the Bank of England was called “phantom securities” by the Bank when it acknowledged reality. Mario Draghi seems to be almost asking for this to happen again. Is this the way that Europe’s banks finally get rid of their bad debts?


It was only on Tuesday that I asked the question is the ECB’s monetary policy “maxxed-out” and in many ways yesterday it confirmed that if it is not, it is very near to it. Of course all central banks are presently facing up to the reality that their policies have diminishing marginal returns but this is particularly an issue for the ECB as they did not work that well in the first place! Also whilst the talk is of expansion there has been a by now familiar contraction this morning already.

Accordingly, on 11 June 2014 EUR 9664.00 million will be repaid in the tender 20110149 by 8 counterparties and  EUR 924.00 million in the tender 20120034 by 4 counterparties.

As The Whispers put it.

And the beat goes on
Just like my love everlasting
And the beat goes on
Still moving strong on and on


It would be remiss of me not to mention the 70th anniversary of the D-Day landings when men like my grandfather mustered such courage as they could and stormed ashore. Happy 70th anniversary to those who survive.




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  • Pavlaki

    What can the ECB do to weaken the Euro – which really is the one thing that would help peripheral markets? If the real economy was the basis of currency strength then the Euro would be much weaker. As you point out, reality and the financial markets have gone their separate ways otherwise traders would be much more cautious about Spain, Greece and the others. I suspect that it will be a political event that will bring back a dose of reality. Catalan independance vote? Syriza in Greece? French economic woes? There are many risks that the financial markets seem quite happy to ignore.

  • Forbin

    Hello Shaun

    good ? none at all

    if they want to boost the economy then how about giving every EU citizen 5,000 Euros to spend? except those in Germany of course , they’re rich enough as it is ;-)

    mind you they might not like it but as the are already paying for everyone else I guess they shouldn’t complain !

    question : why do they say they don’t want to emulate Japan then go and do exactly the same things?

    still , sit back and watch the show , pass the popcorn please !


  • Anonymous

    Excellent plan Forbin, because of unexpected results. Angry Germans revolt and abandon the euro for a Mark. With the result that the ECB gets more inflation than they bargained for ….

  • Andy Zarse

    Mario’s attempt to play “Beggar your currency neighbour” hasn’t exactly got off to a flyer has it? Really he’s being asked to do the impossible, the contradictions inherent in the Euro area mean it will never be otherwise until it becomes an actual single economic entity as opposed to an imaginary one.

  • JW

    Hi Shaun
    Now we have NIRP.
    Don’t want to sound like a broken record, but all the policies from CBs are just exascerbating the divergence of rewards between capital and labour. There is no inflation because V is as near as damn it, zero. So it doesn’t matter how much M they stick in the system it just goes into ‘capital’ and ‘savings’ , demand is still dormant ( unless you count ‘demand’ as represented by investments of capital in London property).
    This ‘cycle’ could take 50 years to play out. Perhaps it never will.

  • GusBmth

    Hello Shaun

    I’m left wondering which central banks desire an appreciation of their currency? Not the ECB, Bank of Japan, Bank of England, the Federal Reserve, the Bank of Japan, or the central banks of Switzerland or China.

    It does seem that the risk of moving from an ultra loose monetary policy to one that is accommodative (let alone neutral) is of a significant multiplier effect through currency appreciation, which neither the Bank of England or the Fed would countenance. This inaction is storing problems for the future.

    Part of the problem is the Euro itself, since the currency is undervalued for Germany and overvalued by a little to a lot for most of the rest. The ECB has an impossible job, with a tool kit which is largely ineffective. All it can try to do is talk down its own currency, but with trade surpluses for the Euro area as a whole, that is a tough task.

  • dutch

    Bang on JW….when they finally do something that gets V moving north,I’ll sit up and lsiten.Till then,they’re jsut changing the colour of the can they’re kicking down the road.

  • dutch

    In general,I’m struggling to see how hoping to increase the price of oil is going to fuel growth.

    Apologies for an awful pun.

    The Danish experience of NIRP hardly inspires confidence that it’ll kickstart lending.

  • dutch
  • Forbin

    I’d stick my neck out here and predict ( predictions are difficult about the future ) that when we get to average 125$ boe next year with at least one spike of 160$ -+ 5$ , then we’ll see who has shorts on!

    we know NIRP dont work but getting BoE / ECB to accept that output gap and dis-inflation posit ( I wont call it a theory ) is also just fantasy will be difficult

    until then I’d go with Ford Prefect’s observation “…a load of useless, bloody loonies!! ”


    Peak Popcorn? or just peak demand for popcorn ?

  • Forbin

    perhaps they should take another “leaf” out of the H2G2 and adopt the leaf as currency

    everyone would be immensely rich and of course there would be this inflation problem …. which I gather , is what the aim is….

    then gain adopt what I mentioned in another post – give everyone 5000 euros but then , here’s the clever bit , put out a rumour that there’s going ot be a bank/savings bail-in

    thus people wont save the money but spend it !

    perhaps if I wrote to Mario……..


  • Jim M.

    €5000 buys a lot of popcorn!

  • Jimbob

    It seems to me that perhaps instead of following the crowd, UK should appreciate sterling. Our balance of payments is always negative anyway. Everything we import would be cheaper, we’d have more money in our pockets, holidays would be cheaper, it may suppress property purchases from overseas. What’s not to like?

  • digger

    Is it time to fill yer boots with Spanish Ten Yr’s?What could posibly go wrong?

  • Noo 2 Economics

    Yes exactly what I was getting at on Tuesday

  • Noo 2 Economics

    I thought that was what they were doing anyway via Forward Guidance coupled with an improving economy? (it doesn’t just have to be interest rates) 7% or 8% up in the last year and counting. Trouble is the GBP isn’t worth that much and a correction will arrive, as to the timing well markets can stay irrational for amazingly long periods

  • Noo 2 Economics

    Hi Shaun,

    I think we are witnessing structural changes of internal devaluations in certain Euro countries via productivity increases unaccompanied by wage rises – ouch! This will take many years to play out, meanwhile the ECB plays for time by trying silly policies to get through the next few months ad-infinitum until the structural changes work themselves through.

    The next move will be ABS purchases a few months down the line, the trouble is, given that banks can’t lend the dirt cheap money they’ve got now, why should they be able to lend even more even cheaper money in the future?

    There is an improving Euro economy, we shouldn’t lose sight of that, we should also consider that the improvements in GDP are not being matched by equivalent reductions in unemployment, or more simply, this is a slow jobless recovery hence the markets surge as they see companies bottom lines improving. This is the price of cheap far east imports. If there is trouble in emerging market economies watch the EZ economy fall into another depression as this will affect Germany tremendously and without the German locomotive where is the EZ?.

  • Anonymous

    Thank you for the link, Dutch. It seems from reading it that the NIRP was reasonably successful in keeping the krone at parity with the euro. So an ECB NIRP might at least be expected to help keep the euro from rising against other currencies. Andrew Baldwin

  • Anonymous

    Congratulations on predicting the ECB move to a NIRP before it happened Shaun.
    My dad was in a bomber plane on D-Day. He was Canadian but actually flew with the RAF like a lot of Canadians. They were bombing in France that day, and didn’t know why until afterwards. We should never forget what the greatest generation did to save us from a Nazi future. Andrew Baldwn

  • Anonymous

    Hi Pavlaki

    I think that Mario Draghi and the ECB will not be smiling as they sit down this weekend and note that the Euro is higher (albeit only marginally) than pre their moves. Along the way conventional economic theory (monetary expansion leads to falling currency) gets at best another appendix!

    However the other financial markets are happy to follow the cash with the Spanish 10 year yield for example equaling the UK Gilt equivalent yesterday.

  • Anonymous

    Hi Forbin

    That is exactly the sort of play to respond to DEFLATION (downwards spiral of output prices and wages) except of course that Greece has that and likely Cyprus too but there are 16 others. Regional policy is invariably too weak and in a currency union without fiscal or political union it is even more short-handed.

  • Anonymous

    Hi Andy

    Whilst Mario Draghi played up the unanimous vote on these measures in his press conference they smacked to me of compromise on the objective. So we got various measures splashed about which are unlikely to have a material impact.

  • Anonymous

    Hi Dutch

    I covered the Danish experience with negative interest-rates and what the ECB should have learnt from it here.

  • Anonymous

    Hi Digger

    As you hint at there is the saying “what goes up must come down”! After yet another surge in prices the yield of the Spanish ten year closed below that of the UK Gilt last night.

  • Anonymous

    Hi Noo2

    The problem for the Euro area is the bottom third if we put it like a league table. Here whilst the media screams deflation/devaluation warnings they mostly miss that these were the objectives of the internal devaluations you mention. Policy makers hoped that inflation would cover it up and if we look at just one variable the oil price it has fallen in Euro terms.

    If the problem countries were outside the Euro their currencies would have fallen. So Germany wins again via a lower currency so far anyway..

  • Anonymous

    Hi Andrew

    Thank you and respect to your father for undertaking what must have taken enormous courage. My grandfather was returning to France with the Royal Artillery via North Africa! One of the ironies of life was that his only ventures abroad were with the British Army.

  • Anonymous

    Hi JW

    On that theme I spotted this earlier on twitter on US nominal wage growth over the past 50 odd years.

  • therrawbuzzin

    My heartfelt thanks to all who took part in the fight against totalitarianism.
    We owe them a far better peace than this.

  • David Lilley

    I repeat below my observations on Marius McDermott’s post on Mario Draggi’s latest CB interventions fyi.

    Some brief observations (I did make a comment but lost it):

    1. Subsequent to your interview with John Lappin at the beginning of the year $220b has been pulled out of the Russian Federation and some of this money will have made its way into UK blue chips to drive up the FTSE 100 and London property prices. This explains why London house prices rose so much in April and May.

    2. UK QE has had a myriad of significant benefits for the UK recovery. If we take just one, the fact that the BoE holds 1/3 of the national debt and that is £375b that we don’t have to pay interest on, that is enough to justify our QE.

    3. G20 coordinated QE would have been better than uncoordinated heavy dipping by the US and Japan. If the ECB takes measures to reduce the Euro that negates Japan’s efforts to reduce the Yen.

    4. Mario’s FFL differs from the BoEs because it isn’t going to the mortgage market. It is going to wealth creation.

    5. I find it hard to differentiate QE from FFL, they both go on the balance sheet. They are both printing money.

    6. I cannot understand how Ireland and even Greece can go to the market to borrow. What are PIMCO and the credit rating agencies saying to gilt investors? How can some Euro periferals have better investment grades than the UK as mesured by their 10 year state bond market prices? Is the Eurozone crisis total history?

  • David Lilley

    On the subject of WW1 and WW2.
    When we cover WW1 we only mention the Western Front and never mention the Eastern Front which consumed more lives and continued until 1929.
    I am not a historian and considered it a soft subject when choosing O levels and therefore not for me.
    On WW2 I often say that is you have heard of Spitfires and bouncing bombs then you probably know nothing of the conflict. Have you heard of Kursk? To every British serviceman who lost his life 100 Russian’s died

  • theyenguy

    The June 5, 2014 Mario Draghi ECB Announcement of NIRP and Targeted LTROs, produced a stunning moral hazard based prosperity in fiat money, and produced the zenith of liberalism, defined as freedom from the state, as investors drove World Stocks, VT, Nation Investment, EFA, Global Financials, IXG, and Dividends Excluding Financials, DTN, to produce peak Equity Wealth, while Peak Currency Wealth, DBV, and CEW, was achieved in the third week of May 2014, and Peak Credit Wealth, AGG, was achieved the week ending May 30, 2014.

    The age of currencies and the era of credit came to an end the week ending June 6, 2014, as stock investors drove Equity Investments to their grand finale finish, manifesting as three long white candlesticks in the weekly chart of the S&P 500, SPY, at a time when the bond vigilantes, called the Interest Rate on the US Ten Year Note, ^TNX, higher to 2.59%.

    Peak Equity Wealth is seen in the chart of World Stocks, VT, relative to Aggregate Credit, AGG, that is VT:AGG, rising parabolically, and then peaking in value in the week ending June 6, 2014.

    The Mario Draghi ECB announcement of NIRP and targeted LTROs produced a blow off stock market top on Friday June 6, 2014, and at the same time has birthed the Beast Regime, to replace the Creature from Jekyll Island, which ruled in liberal policies of investment choice and in schemes of credit. Soon out of the waves of Club Med sovereign, banking, and corporate insolvency, it will rise to rule the world in authoritarianism, specifically in policies of diktat in every one of the world’s ten regions, and in schemes of totalitarian collectivism in all of mankind’s seven institutions.

    The age of diktat and the era of debt servitude commenced on the June 5, 2014, with the mandate of Mario Draghi for a 0.1% surcharge on money held overnight at the ECB. His word, will and way, will compel the debt serf, to experience economic life in regional fascist leader’s policies of regional economic governance, which establish regional security, stability and sustainability.

    Thus the Mario Draghi announcement of NIRP and targeted LTROs was both a climax event, one of peak wealth. and also a genesis event, one of the beginning of a new economic age of authoritarianism.

  • Anonymous

    Everybody suffered – nobody should now be resorting to nationalism or empire building to prop up domestic poll ratings.

    Papua New Guinea, Solomon Island, Guadalcanal and Burma were also very unpleasant places to fight. My granddad served in Solomon Island and probably Guadalcanal – but he never talked much about it.

  • Anonymous

    The banks are betting that Angela Merkel cannot decisively walk away from eurobond default of peripheral countries. Dither, seek consensus and pay up. However, they cannot bet on Merkel bailing out Gilts