ETF Securities Research Blog

Negative rates: The ECB’s policy isn’t working

The European Central Bank’s (ECB’s) policy to give a boost to the Eurozone economy via QE appears to be lacking teeth. What will the ECB do next?The central bank’s QE policy is supposed to stimulate economic activity and ease financial conditions. The problem is that financial conditions have deteriorated in the Eurozone and economic activity is lacklustre. While the ECB’s balance sheet has once again begun to rise, overall Eurozone lending remains stagnant.  Lending volumes have broadly tracked moves in the money supply (M3), which have trended sideways in recent years.



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Are negative rates good for banks?

The banking sector has been one of the worst performers across European equity benchmarks. Clearly such a situation of stagnant loan growth does not help bank balance sheets, but negative rates do not appear to be the cause. In aggregate, deposit and lending rates appear to have been declining broadly in line with each other, keeping margins relatively stable. While negative rates don’t appear to be hurting bank deposits, they are certainly not generating much, if any improvement in loan growth.

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What will the ECB do next?

At some point, moving negative rates will either force banks to lend to increasing risky borrowers or enforce negative rates on its customers (potentially causing depositor flight).  In an uncertain economic environment, neither choice is very palatable for banks. This leaves the option of pushing rates further into negative territory as one that has limited gains. However, if as the ECB suggest, it is still willing to do whatever it takes, it should perhaps be the bank that lends to riskier borrowers. i.e. expand the mandate of its asset purchase scheme to lower quality issuers as other central banks have to kick-start the monetary transmission mechanism. Anything short of such drastic action amidst the current market volatility is likely to leave the market disappointed. Such disappointment could also unwind some of the ‘easy’ competitiveness gains that a weaker Euro has provided.