Key Interest Rate at Historic Low – Penalty Rate on ECB Balance // End of the Measures Not Yet Reached
The key interest rate is at its historic low. The European Central Bank (ECB) has now lowered it again – from 0.25% to 0.15% only. Banks have never had to pay that little for stocking up with fresh money. At the same time, a penalty interest rate on ECB bank balances has been introduced. The financial markets reacted with sharp fluctuations. Hours later, the DAX index cracked the magic 10,000-point mark.
For the first time ever, the deposit rate that is granted to the banks for short-term money parked at the ECB was forced into negative numbers. It dropped from zero percent to minus 0.1% and now costs financial institutions a fee of sorts, if you want to put it that way. At the same time, the credit rate was reduced by 0.35 points to 0.4%.
With this penalty rate, the ECB is pushing credits into the Euro-zone. ECB’s president Mario Draghi criticized in this context, that the banks would loan the money from the ECB, to work with it during the day, and then let it stay overnight at the ECB.
The impact of a negative deposit rate is uncertain. Historically, no large central bank has ever resorted to this step. In Europe, until now, only the Swedish and Danish central banks went this far. These empirical values are, according to estimates by experts, hardly applicable to the entire Euro-zone. However, a weakening of the strong Euro is conceivable. This would initially benefit the strong economy that is driven by an excessive Euro exchange rate. However, especially in Southern European countries, deflation must be avoided. Many analysts expect that banks will simply pass the costs of the negative interest rates onto their customers. This cost transmission will undeniably result in rising interest rates, and ultimately misses the real point of the ECB to push credits in the first place—and even goes against this initiative.
To revive credits, there are a series of refinancing transactions that will be performed with the banks. This way, the banks can borrow up to seven percent of their current lending to central bank money. The costs are calculated from the key interest rate plus 0.1 percentage points.
The ECB expects that this is only the beginning of measures, and that more will be needed. Draghi also doesn’t exclude, for example, far-reaching bond purchases that are considered to be highly controversial in the Euro-zone. Further cuts in interest rates might, on the contrary, be almost impossible.