Dear PGM Capital blog readers.
At its monetary policy meeting, on Thursday, June 5th, the European Central Bank (ECB) announced that it has cut two key interest rates:
- It reduced its main interest rate, the refinancing rate, from a record low of 0.25 percent to 0.15 percent.
- More drastically, it also cut the rate it pays on money deposited by banks from zero to minus 0.1 percent.
Furthermore, Draghi said the ECB would cease sterilizing the liquidity injected from its Securities Markets Program, which involved the purchase of bonds from troubled “peripheral” euro zone countries.
Let’s look at each measure in turn:
CUTTING THE ECB REFINANCING RATE:
The ECB’s “refi rate”, as it is known, is the price that banks pay to borrow funds from the European Central Bank.
By raising or lowering interest rates the ECB can exercise indirect influence over the interest levels that the banks apply to interbank transactions, business loans, consumer loans, mortgages and savings accounts, amongst other things.
During last Thursday meeting, the ECB dropped its rate by 10 basis points to 0.15 percent.
Below table shows the change of interest rates by the ECB during the last 5 years.
| Change date | Percentage |
| June 05 2014 | 0.150 % |
| November 07 2013 | 0.250 % |
| May 02 2013 | 0.500 % |
| July 05 2012 | 0.750 % |
| December 08 2011 | 1.000 % |
| November 03 2011 | 1.250 % |
| July 07 2011 | 1.500 % |
| April 07 2011 | 1.250 % |
| May 07 2009 | 1.000 % |
| April 02 2009 | 1.250 % |
Below charts shows respectively the ECB refi rates during the last 12 months and 15 years.
ECB – interest rates April 2013 – May 2014
ECB Interest rate 1999 – May 2014
Below table shows the comparison of current interest rates of a large number of central banks including the ECB.
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NEGATIVE INTEREST RATES:
Negative interest rates are exactly what they sound like – depositing money actually attracts a charge rather than earning interest.
In this case, the negative rate is applied when Europe’s commercial banks deposit with the ECB.
The idea of this is that the banks will not deposit any more than necessary with ECB and instead will lend the money, or invest in more profitable activities with a higher return.
The reasons why the ECB has chosen to apply negative interest rates is mainly due to the fact that inflation in the Eurozone has fallen far below their 2 percent target.
Secondly unemployment remains high in much of the continent, and growth sluggish. Central banker’s usual answer to that set of problems is simple:
Cut interest rates.
But with the ECB already paying zero percent on deposits that banks park with it, the only way to cut rates further is to go into negative territory.
€400 BILLION IN NEW LOANS:
These are low interest, long term refinancing loans (TLTROs) to boost lending in the “real economy”. They are only available to the non-financial sector and exclude household mortgages.
They are also substantial: from March 2015, all banks will be able to lend up to three times their quarterly net lending to the non-financial sector in the eurozone.
In essence, the TLTRO((Long Term Refinancing Operation) is a cheap loan to banks that they have to lend to specific sectors of the real economy – a lot of small and medium businesses, and not in the financial sector or household mortgages. The loan matures in 2018, but banks who do not lend sufficient cash to the correct sectors will be required to pay it back in 2016, two years early.
Below chart shows the €400 billion per Eurozone country:
ENDING STERILISATION:
This is the most complicated policy change. Since 2010 the ECB has conducted a ‘sterilisation’ program. Instead of simply pumping liquidity into the market like the US, UK and Japanese central banks, the ECB chose to offset its purchases to keep the overall money supply stable.
It did this by offering banks interest bearing deposits equal to the amount of bonds it held each week, thus stabilising the money supply. For every government bond the ECB bought from one the the ‘PIGIS’ countries (Portugal, Ireland, Greece, Italy and Spain), it tried to withdraw an equal amount from banks through these interest bearing deposits
The policy also meant that the ECB could claim it wasn’t quantitative easing because the money supply remained stable.
PGM CAPITAL COMMENTS:
First there was ZIRP (“Zero Interest-Rate Policy”), now get ready for NIRP ( “Negative Interest-Rate Policy”).
The ECB will charge an interest rate of -0.1 percent to banks wishing to store euros within central bank vaults. Domestically, the intention is to prod banks into lending money to businesses as opposed to buying government bonds.
Internationally, the intention is to cause depreciation of the Euro relative to other currencies to increase the competitiveness of European exporters.
Only the “Danmarks Nationalbank” had previously instituted negative interest rates back in 2012. It is important to note that Denmark’s economy didn’t move drastically in either direction as a result.
Even the Keynesians fear the reality of near zero interest rates, something that is referred to as a liquidity trap. Whether you believe in the power of liquidity preference or time preference, the ECB’s move tells us something about the current state of the world economy.
As has been previously stated, depreciation of the Euro versus other stores of value was to be expected and can be seen as a second leg of the currency war, which went into high gear, since the Japanese government has devalued the JPY in the last two years with approx. 29 percent against the Euro as can be seen from below chart.
In the immediate aftermath of the ECB’ announcement the price of gold jumped 1 percent.
There’s no doubt in our mind that more and more individuals within the Eurozone and around the world are realising that Gold and other precious metals represent freedom from the ECB and other Central Banks.
Until next week,
Eric Panneflek