FRANKFURT — European Central Bank President Mario Draghi is contemplating taking interest rates into a twilight zone shunned by the Federal Reserve.
While cutting ECB rates may boost confidence, stimulate lending and foster growth, it could also involve reducing the bank’s deposit rate to zero or even lower. Once an obstacle for policymakers because it risks hurting the money markets they’re trying to revive, cutting the deposit rate from 0.25 percent is no longer a taboo, two euro-area central bank officials said June 15.
“The European recession is worsening. The ECB has to do more,” said Julian Callow, chief European economist at Barclays Capital in London, who forecasts rates will be cut at the ECB’s next policy meeting July 5. “A negative deposit rate is something they need to consider, but taking it to zero as a first step is more likely.”
Should Draghi elect to cut the deposit rate to zero or lower, he’ll be entering territory few policymakers have dared to venture. Sweden’s Riksbank in July 2009 became the world’s first central bank to charge financial institutions for the money they deposited with it overnight. The Fed rejected cutting its deposit rate from 0.25 percent last year. With Europe’s debt crisis damping inflation pressures and curbing growth, the ECB may feel the benefits outweigh the negatives.
“A rate cut could have an important psychological effect in the current environment,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion. “Negative interest rates aren’t an irrational concept. I’m not sure, though, whether in the case of the ECB it will have the desired effect.”
The ECB uses three interest rates to steer borrowing costs in financial markets. The main refinancing rate determines how much banks pay for ECB loans, while the deposit and marginal rates provide a floor and ceiling for the interest banks charge each other overnight.
If the deposit rate was cut to zero or lower, it would discourage banks from parking excess liquidity with the ECB overnight, potentially prompting them to lend the cash instead. Almost $1 trillion is being deposited with the ECB each day.
On the other hand, a deposit rate cut could hurt banks’ profitability by lowering money-market rates, potentially hampering credit supply to companies and households and reducing banks’ incentive to lend to other financial institutions.
“It won’t help the prospect of a functioning money market because banks won’t be compensated for the risk they’re taking,” said Orlando Green, a fixed-income strategist at Credit Agricole Corporate & Investment Bank in London. It would make more sense to lower the benchmark rate, thus reducing the interest banks pay on ECB loans, and keep the deposit rate where it is, Green said.
