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European Central Bank Takes a Radical Step European Central Bank Breaks New Ground to Press Growth
(about 11 hours later)
FRANKFURT — The European Central Bank cut its benchmark interest rate to a record low on Thursday and, in an unprecedented attempt to stimulate the euro zone economy, said it would begin charging interest on deposits held by the bank. FRANKFURT — Banks typically make money on the cash they park at a central bank. Now the European Central Bank wants them to pay for the privilege.
The so-called negative deposit rate has never been tried on such a large scale and is a bid to push down the value of the euro and encourage banks to invest excess cash rather than hoard it in central bank vaults. The move, a so-called negative interest rate, is part of a wide-ranging set of measures aimed at combating the crippling combination of slow growth and superlow inflation.
The European Central Bank cut its benchmark interest rate to 0.15 percent from 0.25 percent, and the deposit rate to minus 0.10 percent from zero. The rate cuts will take effect next week, on June 11. The initiatives, announced on Thursday by the European Central Bank, include the usual fare — interest rate cuts and cheap bank loans. But the bank also showed a willingness to test new tools like the negative interest rate, in a nod to just how worrisome the economic situation has become in Europe.
The central bank will also begin offering four-year loans to banks at the benchmark interest rates, under conditions meant to ensure that lenders use the money to issue loans to businesses. For example, the central bank loans will be designed to discourage banks from using the money to buy government bonds. Taken collectively, the measures send a strong message to investors, businesses, and citizens that the central bank is determined to put Europe on a path to stronger growth.
Mario Draghi, the central bank’s president, said at a news conference that the bank would begin buying packages of loans made to the euro zone private sector, known as asset-backed securities. The measure is designed to push lending to small businesses, but the effect could be limited because the number of securities that qualify is relatively small. The bank president, Mario Draghi, also signaled that he was prepared to go further if necessary. In doing so, he left the door open to employ the same powerful, albeit controversial, bond-buying program that was used to restart growth in the United States.
On news of the measures, the euro declined somewhat against the dollar — which was one of the aims of the central bank’s actions. The weaker currency could help make euro zone exports cheaper, and therefore more competitive, on global markets. “We think this is a significant package,” Mr. Draghi said on Thursday at a news conference. “Are we finished? The answer is no.”
European stocks were also up broadly after the announcement. With European political leaders struggling to address the region’s economic woes, the central bank is aggressively moving to prevent the region from lapsing into the same sort of stagnation that has long afflicted Japan. Just this week, there was news that inflation in the euro zone had fallen to a mere 0.5 percent for the year ended in May, well below the bank’s target of around 2 percent.
Mr. Draghi said the moves adopted Thursday had the backing of the entire governing council of the central bank, which voted earlier in the day — support that he called “an extraordinary degree of unanimity.” Even without outright deflation, it is a perilous trend that can cause people to delay purchases and can undercut corporate profit and job creation. The central bank’s staff expects inflation to return to 1.1 percent in 2015 and 1.4 percent in 2016.
The interest rate cuts, including the move to a negative rate on deposits, had become all but certain after data earlier in the week showed that inflation in the euro zone fell to an annual rate of 0.5 percent in May, a level considered perilously low. The bank is taking a broad tack in its efforts.
The fear is that the minuscule rises in wages and prices could lapse into outright declines — an economically debilitating condition known as deflation, which is characterized by a downward spiral of prices, corporate profits and hiring. Deflation has already plagued the economies of several of the weaker euro zone countries, including Greece. The central bank cut its benchmark interest rate on Thursday to 0.15 percent, a record low, and said it would offer banks cheap four-year loans  —  with strings attached to make sure they lend the money to businesses.
“Ultimately the macroeconomic consequences of a small negative rate are likely to be minimal,” Luke Bartholomew, a fund manager at Aberdeen Asset Management, said in a note after the central bank’s announcement. “But it should put downward pressure on the euro and it is an important signal of the ECB’s deflation fighting intent.”  In addition, the central bank said it was moving closer to making purchases of packages of business loans, another way of funneling credit to companies in troubled countries like Greece that desperately need it.
Imposing a negative deposit rate is meant to give a positive jolt to the euro zone economy. In the annals of central banking, though, negative deposit rates have rarely been tried. Denmark had one until April, but the impact on an economy as large as the euro zone’s is largely unknown. The negative interest rate, which the central bank will impose beginning June 11, is meant to encourage banks to put their money to work to rebuild the battered euro zone. It is also aimed at weakening the euro, by making exports more competitive.
“Negative deposit rates have not been used at this scale before and could have unpredictable consequences,” Christian Schulz, a senior economist at Berenberg Bank, said in a note ahead of the central bank meeting. The markets welcomed the measures. European stocks rose broadly, with the German DAX index reaching a record high.
Many economists have already criticized the moves, which were widely expected, as inadequate to combat the deflation threat that Mr. Draghi has acknowledged. But it is unclear whether such efforts will have the desired long-term effects. The negative interest rate has never been tried on such a large scale, so its real-world effects are hard to predict.
As a result, the reaction and commentary is now likely to focus even more on whether the bank will sooner or later be forced to buy government bonds or private assets in amounts large enough to restart lending in areas of the euro zone that are starved of credit. And many economists wonder whether the central bank is doing enough, given the current economic picture. The central bank stopped short of using its metaphorical bazooka, the large-scale purchases of bonds and other financial assets known as quantitative easing.
The United States, Britain and Japan have all used such asset buying — so-called quantitative easing — to jump-start their economies when there was no room left to cut interest rates. “The conventional measures are all done,” said Guntram B. Wolff, director of Bruegel, a research organization in Brussels. “What remains is quantitative easing.”
But the European Central Bank has been reluctant to do so, in part because of the politically treacherous task of selecting which assets to buy from among the euro zone’s 18 quarrelsome members. But quantitative easing is a tricky proposition in Europe. The bank would have to make the politically delicate decision of what assets to buy from among the euro zone’s 18 members. The Federal Reserve in the United States had much more power to pursue its bond buying several years ago in a program that it is only now winding down.
“There remains no chance of the E.C.B. going for large purchases of sovereign bonds even later in the year, unless a major adverse shock occurs,” Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington, said in a blog post earlier this week. Mr. Wolff and other Bruegel analysts have said the European Central Bank could probably buy bonds issued by European government agencies, as well as corporate bonds and bank debt. It would be more problematic, they said, to buy the bonds of individual countries.
But in response to a question about quantitative easing, Mr. Draghi seemed to leave open that possibility. To embark on any quantitative easing program, Mr. Draghi will have to build consensus among the members of the bank’s 24-member Governing Council. He moved judiciously in the bank’s latest measures, gaining unanimous support for the policies on Thursday.
“We think this is a significant package,” he said of the moves on Thursday. “Are we finished? The answer is no. If need be, within our mandate, we aren’t finished yet.” In the summer of 2012 as the crisis flared anew, Mr. Draghi similarly built internal support for a sweeping promise to backstop the countries’ governments financially and “do whatever it takes” to preserve European unity.
The central bank last cut interest rates in November. During the last month, Mr. Draghi and other members of the central bank’s governing council have sent strong signals that a negative deposit rate was in the works, in part to allow banks to prepare. The backing of Germany, the euro zone’s largest country, will be particularly important. In the past, dissent from the influential German Bundesbank has undercut support for the European Central Bank.
The prospect of a negative deposit rate has already contributed to a decline in the euro currency against the dollar in recent weeks, as investors moved their money to places offering a better return. Despite the challenges, Mr. Draghi laid out on Thursday the most explicit road map to date of what an asset-buying program could look like. The bank, he said, would “intensify preparatory work related to outright purchases.” He indicated that it would buy private sector asset-backed securities.
One of the bank’s aims is to weaken the euro, which allows exporters in the euro zone to sell their products more cheaply abroad. A weaker euro also tends to push up inflation by raising the prices of fuel and other imported goods. The effect could be limited because the number of securities that qualify is relatively small. But the plan could bring the central bank closer to a broader asset-buying program.
The central bank aims for an inflation rate of close to 2 percent. For most of its history, it was preoccupied with keeping inflation from exceeding that rate. But in recent months, the bank has been struggling to raise inflation closer to that target, which the bank considers an optimal level because wages and prices would rise fast enough to stimulate the economy, without overheating it. The European Central Bank will also begin offering four-year loans to banks at the benchmark interest rates, under conditions meant to ensure that lenders use the money to issue loans to businesses. Banks will be required to show that their net lending to firms increased as a result of the central-bank cash. If not, banks would be forced to repay the money early.
As an indication that pumping up the inflation rate could be a slow process, Mr. Draghi said Thursday that the central bank is forecasting a rate of 0.7 percent for this year, 1.1 percent next year and 1.4 percent in 2016 — still short of the bank’s target of just below 2 percent. It is unclear whether euro zone banks will respond to the central bank’s action. Many banks are already struggling with large portfolios of problem loans.
Economists regard modest inflation as a good thing, although they argue about the ideal rate. Inflation helps debtors because it effectively lowers the value of debts. And inflation helps reduce the risk that, because of imperfections in the way prices are measured, deflation will infect the economy before policy makers can take countermeasures. “The rate cut, assuming it filters to the market, will assist, but not enough,” said Petros Haidemenos, the general manager of Kalamea Foods, a midsize importer that distributes brands like Kettle Chips, Fiji water and Dippin’ Dots ice cream snacks in Greece.
Deflation is notoriously difficult to combat. Japan has been trying to escape the effects of deflation for the better part of two decades. Like many Greek businesses, Kalamea Foods has struggled for the last several years, partly because banks lowered or closed credit lines after a wrenching recession. But given the high level of nonperforming loans at Greek banks, Mr. Haidemenos said he doubted that the measures taken on Thursday would unleash the liquidity needed to help jump-start business activity.
Several countries in the euro zone are already suffering from deflation, in particular Greece, where many workers have suffered steep declines in wages. Companies have been forced to cut their prices, and tax revenues have declined, making it even harder for the Greek government to service its huge debts. “The reason banks are not lending is because they know they will lose the money,” he said.