At today’s European Central Bank post-meeting news conference, we discovered that ECB President Draghi and his fellow Governing Council members are pulling on their walking boots for a trip into unexplored territory namely, negative interest rates.
We all dozed through his opening, oft-repeated remark that the ECB, "stands ready to act", (if economic developments so-demand), but then, much more significantly, he repeated the phrase in response to a journalist’s question about whether the ECB would ever consider taking the Deposit Rate negative-that counts as a hint in my book, the markets seemed to agree, and everyone sat up in their seats to listen with rapt attention as he pushed home the hint by saying the ECB would "cope" with any unintended consequences of negative interest rates. That removed the last obstacle-hitherto, the ECB’s response to negative rate speculation has always been to refer to such fears. He also repeatedly emphasised the extent to which the Governing Council feels the transmission mechanism from low ECB policy rates to increased and cheaper lending to real people and businesses had healed itself, even in the Periphery, i.e. therefore, conventional policy tools are once again back in play and potentially efficacious.
I was also impressed by the way he didn’t repeat his usual mantra about not pre-committing to interest rate moves-he usually leaps down anybody’s throat if they’re silly enough to try and get him to do that!
Here’s what he meant when he said the ECB would "cope" with any nasty side effects of negative policy rates. The most frequently sighted potential undesirable consequence is an inability on the part of banks to fund themselves adequately, because Money Market Funds will be unwilling or statutorily unable to lend to banks at negative interest rates, for fear of "breaking the buck" in terms of their redemption prices to investors. So, the story goes, banks will become illiquid. Again.
However, the ECB has already proved to us all that liquidity is its party piece-witness its Long Term Refinancing Operations and Outright Monetary Transactions, (well, witness the latter’s description at least, since it’s yet to be used in practice). Liquidity is what the ECB feels it’s there for, and what its mandate allows, as opposed to anything that smacks of the provision of deficit funding to governments.
This is what Draghi meant when he said the ECB would "cope". Even as he spoke, the ECB’s boffins were no doubt crafting some new, diabolically clever liquidity scheme.
The psychological effects of actually paying money every day to deposit money at the ECB would have quite a dramatic effect upon banks-more than that to be expected from a cut of only 0.25 per cent, and not only would this small move down in interest rates have an amplified effect upon banks’ willingness to lend, it will also lead the man in the street to think again before putting his money on deposit. Why not go and spend it-surely all these weird experiments monetary policy must lead to inflation at some stage, so maybe better to buy that car now, before it costs more next year?
And if it works for the ECB, why not for the Bank of England and its incoming and undoubtedly imaginative new Guv’, Mark Carney? His defeated Deputy, Paul Tucker, has already floated the concept.