Recently the European Central Bank cut its refinancing rate by 25 basis points to 0.5% which is a record low. The catalyst for this rate cut was the continuation of the decline in the manufacturing sector of the EU. Although this lower interest rate did improve the mood of investors ECB President Mario Draghi did hint at the prospect of negative interest rates on deposits at the ECB. This would mean that trading banks would pay for the privilege of parking their money in the ECB. What are the options for banks?
1. The ECB’s thinking is that banks wouldn’t want to pay interest to the ECB and therefore would try and lend money to consumers which would stimulate growth in the real economy.
2. The banks could stop depositing money at the ECB and simply keep it themselves – like a consumer you would keep money ‘under your mattress’.
3. The banks could continue to deposit money at the ECB and pass on the cost of negative interest rate to the consumers who borrow. This would likely reduce the level of borrowing which is exactly what the ECB don’t want.
With the US economy starting to grow is QE a more applicable policy instrument for the EU economy? Will Draghi follow Bernanke? Its seem that he is not keen on the ‘helicopter drop’ but with a 0.5% refinance rate what other options are available?