- The European Central Bank on Thursday cut its interest rate 10 basis points to a record low of -0.5% and will in November kick off a fresh round of stimulus.
- Trump tweeted his approval, following a series of attacks on the Fed to cut interest rates to zero or below.
- Most economists agree that it is a highly unlikely scenario in the US, but Europe has had negative interest rates since 2016.
- For Europe, it’s helped stabilize the economy and the euro in a time of turmoil, but it’s squeezed banks’ profits.
- The risk of negative rates to banks is that it will stop lending or pass the cost onto consumers.
- View Markets Insider’s homepage for more stories.
Europe just cut interest rates, and Donald Trump wants the US to follow suit.
On Thursday Trump took another swipe at the Fed, after earlier saying the Fed should cut rates below zero.
While most economists don’t think the US would even get close to that, Europe has had negative rates since 2016.
That’s because Mario Draghi, the outgoing ECB president said he would take a “whatever it takes” approach to stabilizing Europe. On Thursday, Draghi cut rates a further 10 basis points to a record low of -0.5%, and announced bond buying at a monthly pace of €20 billion from November 1.
“The Governing Council now expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon,” the ECB said in a statement on Thursday.
Draghi did hit back at Trump during the conference: “We have a mandate. We pursue price stability and we don’t target exchange rates. Period.”
Since its first foray into negative rates, Europe’s economy, which relies heavily on the US and China, has slowed.
Europe’s economy was dealt another blow earlier on Thursday — Europe’s industrial production in July fell 0.1%, signalling a poor start for the third quarter.
What have negative rates done to Europe and its banks?
Prior to Draghi taking over the ECB, Europe’s economy was stumbling, hence a wave of cuts that eventually turned negative in 2016. Since then, they haven’t moved, and Europe’s economy has recovered a bit since.
The euro stabilized and inflation rates are moving towards the target of 2%.
However, despite the obvious positive effects of the lower rates, criticism has come from the likes of Deutsche Bank and UBS, as commercial banks are the ones who feel the heat when it comes to negative rates.
Commercial banks in Europe are the main source of lending when it comes to households and small and medium-sized companies, and are therefore vital to the European economy.
Because “commercial banks hold their deposits within central banks, if rates are positive they gain from it, but negative rates actually act as a charge” for the likes of UBS and Deutsche, Jack Allen-Reynolds, senior Europe economist at Capital Economics, said in an interview with Business Insider before the ECB announcement.
This charge is a “burden,” Volker Hofmann at the Association of German Banks said, according to the Financial Times, which cited Hofmann at a conference as saying that lenders pay €7.5 billion ($8.27 billion) a year in negative rates on the excess deposits they hold at the ECB.
“It is a remarkable burden for banks who find it more or less impossible to convey this cost to retail savers,” the Financial Times cited Hofmann as saying.
The risk is that if rates go too low, then it could hit the “reversal rate,” where lenders like UBS and Deutsche then pass the charge on to consumers.
So far this hasn’t happened and banks have shouldered the cost and lending rates have been very positive around 3% to 3.5% according to Allen-Reynolds.
But Europe’s titans of banking are warning that this could change as it’s hurting profits.
“Banks’ interest margins are under pressure in this environment and that’s not going to change,” Martin Zielke, head Commerzbank, said at conference according to The Financial Times. “I don’t think it is a particularly sustainable or responsible policy,” the newspaper cited him as saying.
The other issue is once rates go below zero there’s nowhere to go from there.
The other problem for the ECB and incoming president Christine Lagarde is that once rates go below zero “the ECB runs out of ammunition,” says Allen-Reynolds.
“When interest rates are so low, there is not much further central banks can go. At that point, you’re looking at fiscal policy to provide some stimulus and that’s up to individual governments,” said the economist.
For Jerome Powell, this isn’t really an issue as there a number of cuts before interest rates hit zero, but for Europe monetary policy actually has become quite a weak tool and its something that Lagarde will be focusing upon when she takes over.
Lagarde said: “While I do not believe that the ECB has hit the effective lower bound on policy rates, it is clear that low rates have implications for the banking sector and financial stability more generally,” according to the Financial Times.
The FT cited Lagarde as saying that the ECB should “closely monitor whether adverse side effects may emerge in the future, the longer low interest rates are in place.”