ECB has scope to reduce the stimulus

Since ECB boss Draghi hinted at the March interest rate meeting that the central bankers considered adjusting their forward guidance, speculation has risen about how and whether a reduction of monetary policy stimulus could be implemented.

Excess liquidity in the Eurozone has meanwhile increased to more than EUR 1.5 trillion, partly due to ECB bond purchases, and will rise further to hit the EUR 2 trillion mark as the program continues. Central bank liquidity in the market is nevertheless distributed very heterogeneously among the various euro countries. More than 70% of excess liquidity is concentrated at German, French and Dutch banks. German commercial banks hold significantly more central bank liquidity at the Bundesbank than they demanded as part of tender operations or has accrued to them as part of bond purchases.  This means in turn that German commercial banks are affected to a much greater degree by the negative deposit rate than other European banks. Not only this situation necessitates a rethink on the negative deposit rate policy, however.

The argument that a negative deposit rate forces commercial banks into lending more does not look very convincing. It is clear, for example, that banks in the European periphery park excess liquidity at their respective central bank to a comparatively minor extent. Given this, these banks have no need to expand their lending activities to avoid the ECB’s punitive rates. Lending in core Europe is on a relatively robust trend, by contrast. Banks in core Europe are almost being punished for their business policies as a consequence: they offer a high degree of security, which is why money is parked with them, and they extend loans. Given all the aforementioned we would consider it a reasonable move for the central bank to raise its negative deposit rate – as part of its extraordinary monetary policy measures in the battle against deflation risks – at least far enough to establish symmetry in relation to the main refinancing rate. Lifting the deposit rate from currently -0.40% to -0.25% in the autumn – once landmark elections in Europe are over – would constitute a corresponding move. The monetary policy stimulus remains expansive with a continued negative deposit rate, but with such a measure the ECB can reduce the alarm level.

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