European Central Bank sets negative interest deposit rate

Posted Jun 5, 2014 by Ken Hanly
The European Central Bank has adopted new measures to attempt to stimulate the sluggish EU economy. The refinancing rate is already a low 0.25 per cent but that has been cut to just 0.15 per cent.
President of the European Central Bank (ECB) Mario Draghi attends a press conference in Frankfurt am...
President of the European Central Bank (ECB) Mario Draghi attends a press conference in Frankfurt am Main, on June 5, 2014
Arne Dedert, DPA/AFP
The deposit rate has been cut from zero to -.10 per cent. Banks will in effect be punished for depositing funds rather than using them to make loans or investing them elsewhere. The move also is meant to help save the EU from deflation.
Mario Draghi head of the ECB claimed that he would "do whatever it takes" to save the EU economy and save the currency, the euro, and he suggested that his moves might just be the first of many. If he thought the situation required it, he said would proceed with further quantitative easing. This is the first time a major central bank has introduced a negative interest rate designed to increase lending and also spending.
Draghi's moves caused an immediate decline in the value of the Euro to a four month low. Peter Kinsella, of Commerzbank in London said: “This is definitely a game changer, They are throwing the kitchen sink at it. The euro is going to depreciate.” Inflation is still far below the target rate of close to two per cent. Draghi predicted the rate to be just 0.7 per cent for 2014 but by 2018 it is expected to be 1.5 per cent. Given the lack of a significant upward movement in the inflation rate Draghi said: “The key ECB interest rates will remain at present levels for an extended period of time in view of the current outlook on inflation..We don't see deflation. We don't see the typical feature of the self-fulfilling negative prophecy," He claims that with an increase in euro zone growth interest rates will trend higher.
The EU economy is suffering not just from the threat of deflation it also has a very high overall unemployment rate of 12 per cent. However countries such as Spain, Portugal and Greece have rates as much as twice that with even higher rates among young people. The negative interest rates on deposits may not achieve that much as for some time now at the zero interest rate banks have much less on deposit. Banks have around 100 billion Euros on deposit compared with about 800 billion just a few years ago.
Another measure Draghi introduced was a lending program of about $545 billion US that can be used to provide credit to households and businesses but cannot be used for mortgages. Finally the bank will stop the practice called "sterilizing" or offsetting bond-buying by draining out the same amount as the purchases introduced into the economy. If all of this does not work in the desired fashion the next step may be along the lines of the quantitative easing(QE) used in the US. However should the ECB decide to buy bonds they will be private bonds in all likelihood since countries in northern Europe believe that buying country bonds would be a type of bailout for countries in southern Europe that are in financial trouble.
In general stock markets gained after the policy announcement by the ECB. How long this will last may depend upon whether the moves actually stimulate growth in the EU economy and some inflation. Lars Svensson, a former Swedish central banker and a top monetary economist said:, "Showing that zero isn't the lower bound may have some additional demonstration effect."