Why ECB’s Negative-Rate Policy is Out of Order

Just as elsewhere, the ECB’s exit from loose monetary policy is more complex than its introduction

By Richard Barley

If the eurozone economy continues to improve and political fears subside further, then more pressure will build on the ECB. Photo: daniel Roland/Agence France-Presse/Getty Images

The European Central Bank is taking its foot off the quantitative-easing gas, with bond purchases slowing to €60 billion a month in April from €80 billion. But it is keeping the negative-interest-rate pedal floored. That looks increasingly odd.

Sure, the ECB isn’t rushing for the exit from loose monetary policy. Friday’s flash eurozone inflation reading of 1.5% for March, down from 2% in February, gives policy makers room to take a cautious stance. But the sequencing of the ECB’s moves is still open to question.

The ECB has said it would hold interest rates at current or lower levels until well after its bond-purchase program comes to an end. That would match the path taken by the Federal Reserve, which didn’t raise rates for more than a year after it wound down quantitative easing.

But it isn’t clear the ECB should simply follow the Fed. For a start, the Fed’s interest rate never broke below zero, while the ECB deposit rate is at minus 0.4%. A negative nominal interest rate is arguably a more unconventional tool than bond purchases. And the ECB carried on reducing rates alongside its bond-buying program.

When they were initially introduced, negative rates appeared to be an alternative to bond purchases for the ECB. Quantitative easing was difficult in the eurozone because of the fragmented nature of bond markets and political sensitivities. But the ECB ended up buying bonds, and it is QE that has the bigger influence on markets—in particular in helping to reduce long-term interest rates for southern European countries. Negative interest rates have fallen from favor due to their potential side effects on the financial system, and the way they may encourage excess saving.

For a while the two policies were linked: the ECB wouldn’t buy bonds yielding less than the deposit rate. That became a constraint on purchases, particularly in Germany, raising doubts about the ECB’s ability to carry out its monetary policy.

But the link has been broken, and the ECB is now buying bonds even at yields below the deposit rate. The last cut in the deposit rate came alongside an increase in bond purchases to €80 billion a month from €60 billion in March 2016 as deflation fears bit. The two steps were in unison, but only one is being reversed. The asymmetry born of the ECB’s guidance—which made sense in the depths of a deflationary panic—is clear. But taken at face value, it means negative rates could persist well into 2018.

If the eurozone economy continues to improve and political fears subside further, then more pressure will build on the ECB. Negative interest rates always looked like an anomaly. They look like even more of one today.

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