Welcome to the Currency War, Part 16: Interest Rates Go Negative
This morning the European Central Bank tried something different. As Bloomberg reported:
ECB President Mario Draghi reduced the deposit rate to minus 0.10 percent from zero, making the institution the world's first major central bank to use a negative rate. Policy makers also lowered the benchmark rate to 0.15 percent from 0.25 percent.
The promise of further measures today "has stoked up hopes that the ECB is going to unleash a huge bazooka on the market in the press conference," said Philip Shaw, chief economist at Investec Securities Ltd. in London. While he thinks that quantitative easing is "very unlikely" now, "it may well be that what the ECB just said is stoking up hopes that QE could be on the cards after all. "
Later in the day, Draghi fleshed out his thoughts in the aforementioned press conference. From Business Insider:
The ECB is "intensifying preparatory work for outright purchases in the ABS [asset backed securities] market." It will also suspend its weekly securities market program (SMP) sterilization.
The Q&A has begun. Here are the key highlights:
There will be additional reporting requirement to ensure lending goes to real economy. For all practical purposes the ECB has reached the lower bound of rate policy, Draghi says.
"The main reason to commit to sterilization by my predecessor first and by myself later was based on the effects that this additional liquidity might have on inflation," says Draghi. "This decision takes place in a background characterized by low inflation, weak recovery and weak monetary and credit dynamics, that's the reason for suspending this commitment."
"Being able to have unanimity on such a complex set of instruments means a very very extraordinary degree of consensus," says Draghi. "What is in this TLTRO that makes it different? 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."
We don't see deflation says Draghi.
"There is a deep misunderstanding here. The rates we've changed are for the banks, not for the people," says Draghi. It's wrong to think we want to "expropriate savers. ...The concerns of savers should be taken very seriously." Draghi however adds that the decision to lower rates for households is the decision of banks, not the ECB.
Anyone who finds this surprising hasn't been watching Europe's inflation numbers. As most of the eurozone including, recently, Germany slipped towards deflation, it was clear that the European Central Bank would have to launch a new currency war offensive, and soon. So here it is: negative interest rates on bank excess reserves (though not yet on consumer bank accounts) along with direct infusions of cash into the banking system.
This will have a modest effect on bank lending and economic activity, but it won't stop the eurozone's downward spiral because liquidity doesn't fix insolvency. In other words, if the system's collateral isn't as valuable as the debt it supports, then the system is in trouble. And coercing banks into making more loans against inadequate collateral will not help the situation.
So the next, equally inevitable stage in Europe's offensive will be some form of QE, and apparently the ECB has decided that asset backed bonds will be the instrument of choice. The idea is that by buying, say, mortgage backed bonds with newly-created euros, the ECB will be able to direct those euros back into the housing market, which will in turn get people spending again. This, by the way, is the script the US followed in the first half of the 2000s which produced the housing bubble and the subsequent crash.
But before this bubble bursts, the euro will fall due to rising supply, which is the same thing as saying that the dollar will soar. This will be deflationary for the US, producing a string of "unexpected" misses in corporate earnings, GDP and inflation, and will leave Washington with no choice but to respond with renewed debt monetization and money printing and in all probability negative interest rates of its own. And so it will go, until we figure out that depreciating fiat currencies against each other is a zero-sum game that makes the rich richer and everyone else much poorer.
One would expect gold to be the main beneficiary of crazy policies like negative interest rates, and it did pop on Draghi's news. But the ongoing manipulation of precious metals prices makes this far less of a sure thing than theory and common sense would imply. Fundamentals always win in the end, but in a world of manipulated markets the timing is completely unknowable.
Previous articles in this series are here