When will the Euro and ECB be able to escape from negative interest-rates

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by Shaun Richards

Last night brought us a reminder of a symptom of a long-term issue facing the Euro area and hence the European Central Bank or ECB. It was an unintentional consequence of the US Federal Reserve Minutes.

Participants generally emphasized that, as in the
previous normalization episode and as expressed in the
Committee’s Statement on Longer-Run Goals and Monetary Policy Strategy, changes in the target range for the
federal funds rate should be the Committee’s primary
means for adjusting the stance of monetary policy in
support of its maximum-employment and price-stability

So they see interest-rate rises as their primary weapon in response to the rise in inflation they have been seeing. A bit late you might think ( I certainly do as you are supposed to get ahead of events rather than chase them…) but the point here from the ECB’s point of view is that it will focus attention on its inability to do so.

We can analyse this via the words of ECB President Lagarde from the 16th of December so only a day or two different in timing.

So you need the three conditions, and we also have forward guidance when it comes to when we start raising interest rates, and that is clearly shortly after[2] we finish purchasing assets. So that gives a clear indication of where we are positioning ourselves and what will trigger a move in that respect.

That is significant because she also announced an increase in one of the ECB QE programmes.

we decided on a monthly net purchase pace of €40 billion in the second quarter and €30 billion in the third quarter under the asset purchase programme (APP). From October 2022 onwards, we will maintain net asset purchases under the APP at a monthly pace of €20 billion for as long as necessary to reinforce the accommodative impact of our policy rates.

So taking those words literally there will certainly be no rise before October and it is implied for some time after. This was in fact further reinforced by President Lagarde.

“As I’ve said before, it’s very unlikely that we will raise interest rates in the year 2022. That still stands,”

So we have a clear contrast between US interest-rate trends and those in the Euro area. Another example was provided by Neil Kashkari of the Minneapolis Fed.

My own submission to the SEP also showed an increase, from zero expected rate increases in 2022 in my September submission to two increases in December.  ( SEP= Summary of Economic Projections)

This matters because whilst Neil is presently a non-voter he is perhaps the least likely to be in favour of interest-rate rises. So if he is thinking about 2 of them….

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By contrast President Lagarde is a long-term supporter of negative interest-rates.

FRANKFURT—Subzero interest rates in Europe and Japan are “net positives” for the global economy, International Monetary Fund chief Christine Lagarde said Tuesday, ( Wall Street Journal 2016 )

Negative Bond Yields

This is an issue which is more important than it used to be for two main reasons. Firstly the fact that bond yields went negative in the Euro area and even in places like Italy are very low. Secondly more borrowing especially for mortgages is at a fixed-rate these days meaning bond yields are more important as both a signal and an economic agent. This is on the agenda because the benchmark yield ( ten-year ) in Germany is nearing 0 as it is -0.05% as I type this.

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So Germany may actually have to pay something for its new borrowing. It will still be paid at the shorter end but is already paying at the longer maturities. If we start with the consequences for governments Italy now has a benchmark yield of 1.3% which in historical terms is still very low but the cost will be rising as we recall that the debt keeps piling up there in spite of the official forecasts for it to be lower.

There will be other economic consequences as upwards pressure arrives for fixed-rate mortgages and business borrowing.

There is an irony here in that this is happening in spite of the rhetoric and likely policy from Christine Lagarde. In fact in some ways it is driving it as she will not want issues for Italy especially after her early claim that she is not there to deal with “bond spreads” that led to a high-speed handbrake turn.


This is in many ways the crux of the matter for the ECB which has consistently argued that it is an inflation targeter. But the heat is on with inflation near 5% and the target at 2% leading to quite a swerve.

Our new staff projections foresee annual inflation at 2.6 per cent in 2021, 3.2 per cent in 2022, 1.8 per cent in 2023, and 1.8 per cent in 2024 – significantly higher than in the previous projections in September.  ( ECB)

So having pumped inflation up with the negative interest-rates and QE they now justify doing nothing based on their forecasts for 2023 and 2024.One problem is that they got last year wrong and indeed this year. Or as they put it the forecasts are “significantly higher” than only 3 months before. The next one is their willingness to put theory and forecasts over the reality of higher inflation. Their problem in this area got worse this morning.

In November 2021, industrial producer prices rose by 1.8% in the euro area and by 2.0% in the EU, compared with
October 2021, according to estimates from Eurostat, the statistical office of the European Union…..In November 2021, compared with November 2020, industrial producer prices increased by 23.7% in both the euro area
and the EU.

This is especially significant if we look at the index which was set at 100 in 2015. It went above 106 in the autumn of 2018 and then drifted a little lower but now has surged to 126.7.

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In essence the question is when can the ECB raise interest-rates? Which quickly morphs into if it can? If it does not do so at these levels of inflation then it seems less likely to do should it moderate. This does matter because once we move on from the cheerleading for negative interest-rates and yields it creates problems. It helps keep zombie companies alive ossifying the economic structure. It affects long-term saving and pensions as who wants a forecast that you will get back less than you put in. It hurts the banks which is why they got a special -1% interest-rate from the ECB. Also it leads to asset price bubbles in houses,bonds and equities.

International evidence suggests that a one percentage point decrease in the interest rate will cause an increase in real estate prices of 6% to 8% over the following three years. ( European Parliament)

Another major issue is the hand wringing over inflation. It is making consumers and workers worse off which is the opposite of what monetary policy is supposed to do but Lagarde and her colleagues seem to be hoping that people will not notice this. It is really quite extraordinary as they want the credit for boosting the economy with their stimulus but then to hide from a serious consequence. Or as I have argued all along monetary policy can help, but it is not a magic wand because after a certain point inflation comes knocking at your door.


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