The ECB opened up two more doors today, though it hasn’t walked through them: first on securitization of SME loans into ABS, and second, to lower their deposit rate to negative levels, which the OECD also recommended over four months ago. Specifically, Draghi said the ECB is technically ready for, and “has an open mind on a negative deposit rate”, adding that while such a move would have unintended consequences they would cope with those negative effects. This doesn’t mean that they will be able to mitigate or avoid that collateral damage, though they might try. These might include the destruction of money market funds, dangerous financial engineering, distortions in certain markets, and increasing the interdependence between banks and sovereign risks. But they’d accept them as a necessary evil. Further disinflation and disappointing economic data will probably trigger such experimentation, rather than risk certain failure in meeting their inflation mandate by keeping real rates too high.
It is interesting to note how the ECB’s thinking on negative deposit rates has evolved:
Back in July 2012, tired out from LTROs and the rate cut implemented in that month, they weren’t even thinking about doing anything non-standard… less than a month later came the “whatever it takes” ad hoc that led to the OMT, but Draghi and the ECB were not even thinking about going into the unknown territory of negative nominal interest rates. Indeed, cutting the depo rate to zero proved extremely powerful, for a time.
Excerpts from that press conference:
Question: Is the Governing Council concerned about the impact of negative carry via negative yields for bonds and such, especially for non-banks? And does the Governing Council not think that a negative deposit rate could be risky and, if so, does that mean that the Governing Council rules out negative rates?
Draghi: We have not discussed this and, as usual, we will not commit to any further measures.
Question: My first question probably paraphrases what my colleague has just asked. In principle, would you consider operating under negative deposit rates?
And my second question is this: you have repeatedly stated that credit has mainly been driven by demand in recent months. Does that mean that the ECB is operating close to, or under, a liquidity trap?
Draghi: No, we do not think we are in that situation. And, frankly, on the other part of your question and your colleague’s question, I would say that, at this point in time, we are not really elaborating on various non-standard situations in which we may find ourselves. So, at this point in time we are not actually thinking about that.
Question: Is there any concern on the Governing Council that the ECB is now running low on policy options and that, if there is not an improvement as expected or hoped, there will be a need to turn to some more unconventional measures?
Draghi: No, there is no such feeling that we are running low on policy options. We still have all our artillery ready to contain inflationary risk in order to pursue the objective of price stability. Let me say one thing: when I say pursue the objective of price stability, I mean on both sides or in both directions.
In November 2012, Draghi was asked:
Q: …Governing Council member Ewald Nowotny said that, for him, a negative deposit rate, should you decide to cut interest rates, doesn’t appear to be a realistic prospect to him. Is that an assessment that is shared in the Governing Council?
Draghi: We did not discuss matters related to your second question.I want to elaborate on further non-standard measures at this point in time.
Then, at the end of last year, there suddenly was more discussion, and some readiness and preparation! In December-2012’s press conference, Draghi replied to a question as follows:
“On the issue of negative interest rates on the deposit facility, there is nothing new to report. As Mr Praet recently has said we are operationally ready, but the discussions in this respect did not go into any depth. We briefly touched upon the complexities that such measure would involve and on possible unintended consequences. But we did not elaborate on this any further.”
But two months ago, the ECB seemed to backtrack, having more reservations about the cons and uncertainty about the pros:
March press conference: …And my second question is whether the Governing Council has actually discussed a cut in the deposit rate, and what you think the biggest risks would be if you implemented a negative deposit rate?
Draghi: … The answer to the second question is the following: we have looked at that and we do not commit to doing anything. The unintended consequences of a measure like that can be serious, as similar experiences in other monetary jurisdictions have shown. I think in the past I have described this as “unchartered (sic) waters”, which is all I can say on the matter.
Finally, last month’s presser was all about the Cyprus fiasco, and the negative interest rate did not come up in the Q&A.
One further unanswered question is if further repo and marginal lending rates will come first, compressing the “corridor” between its three different rates (deposit, refi, lending) to Czech-type levels first (see below). That seems likely.