Monetary Insanity: ECB Considers Negative Interest Rates, Looking for Clues From Denmark; Anteaters and Hurricanes

The ECB is now pondering monetary insanity: ECB's Coeure says negative bank deposit rate an option

Cutting the deposit rate the European Central Bank offers lenders in the euro zone below zero is an option, ECB Executive Board Member Benoit Coeure said on Friday.

Speaking in Mexico, Coeure said the bank needed to take the rate down 25 basis points to zero to match its cut in the reference rate.

He said policymakers would need to consider whether it could take the deposit rate below zero, which would mean the central bank would start charging banks for the privilege of parking spare cash in the ECB.

"It's still possible," Coeure told students at an event in Mexico City. "It's true that we are hitting a psychological limit at zero. And it's unclear whether markets can function at negative interest rates. Some of them can."

"Some of them apparently can't. So before making the next step, which would be moving the deposit facility to a negative yield, we'll reflect about it," he added.

Denmark introduced a negative interest rate this month and the ECB is watching closely how the move plays out.

Negative Rates in Denmark, Switzerland

The Wall Street Journal discusses Negative Rates in Denmark, Switzerland.

July 6, 2012

For the first time ever, the Danes cut one of their official interest rates to below zero on Thursday.

Struggling against a tide of foreign capital seeking a safe haven, the Danes are trying to keep their exchange rate from rising to the point of throttling domestic industry. Unfortunately, one way or another, the struggle to retain competitiveness is likely to be a forlorn hope.

Denmark’s certificate of deposit rate was chopped by a quarter point to where CDs now yield minus 0.2%. Which is to say holders of these certificates willingly pay the Danish government a fifth of a percentage point for Denmark to hold their money.

Like Denmark, Switzerland is once again struggling against these capital flows, albeit nowadays they’re coming from closer to home.

Market rates on various short-dated Swiss, German and Danish government paper have been negative during the past year. Indeed, what started off as negative rates on the most short-dated bills has been creeping along the yield curve. On Friday morning, yields on the German two-year note, known as the Schatz, dropped to minus 0.01%.

So far, Switzerland and Denmark have managed to limit their currency appreciation. Switzerland has heroically been defending the 1.20 Swiss francs to the euro floor by buying euros frenetically.

Anteaters and Hurricanes

Denmark and Switzerland want to stop capital inflows and currency appreciation.

In contrast, the ECB does not want to stop currency appreciation nor does it want acceleration of bets against the euro. Rather, the ECB wants to stop capital flight specifically from Greece, Spain, Italy, and Portugal. 

Moreover, and also in contrast to the problems in Denmark and Switzerland, the ECB is struggling with dramatically different sovereign bond rates in the Southern Europe (notably Greece, Spain, Italy, and Portugal), than the rest of Europe.

Such conditions only apply to monetary unions, not individual sovereign countries.

The only thing the ECB is likely to achieve if it goes ahead with this ridiculous idea is cause a massive cash withdrawal from money markets in general, not halt capital flight in Southern Europe.

Negative rates sure will not spur lending, another possible goal of the ECB.

Yet, Benoit Coeure wants to study results in Denmark. Good luck with that.

All things considered, studying negative rates in Denmark for application across the entire ECB is like studying anteaters when the problem is hurricanes.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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