About negative interest rates
■ The ECB reopened the debate over the effective floor for its interest rate policy stating it is considering another cut in its deposit facility rate.
■ The negative rate policy is intended to loosen financial and monetary conditions, in particular through its effect on the exchange rate.
■ The effects on lending and long-term rates are more mixed. In both cases, other monetary policy instruments – particularly quantitative easing – are more crucial.
At the press conference that followed the ECB’s latest monetary policy meeting, Mr Draghi hinted at the possibility of another cut in the deposit facility rate as early as December. To recap, since it was lowered to -0.20% in September 2014, it has been considered as the effective lower bound for the central bank’s interest rate policy.
Assets can be held in the form of either (non-interest-bearing) cash or (interest-bearing) securities, and interest rates represent the return required by the lenders to forgo liquidity. In theory, interest rates cannot then be negative. In practice, however, holding cash comes with costs. These derive, for instance, from storage and transportation. While there is a lower bound to interest rates, this floor actually stands below zero.
Four central banks are currently operating with negative rates, including the European Central Bank1. This policy is implemented through the Deposit Facility rate (DFR), which has been negative since June 2014 and currently stands at -0.20%. In concrete terms, this means that commercial banks pay a penalty of 0.20% on the amount of excess reserves they deposit with the ECB whether on the depositit facility or current account.
The ECB’s monetary policy consists of a corridor formed by three interest rates: the interest rate on the main refinancing operations (refi rate) and two rates on permanent facilities – the deposit facility and the marginal lending facility – marking the lower and upper limits respectively of the corridor. By setting its policy rates, ECB influences the overnight interest rate (Eonia) in the interbank market which fluctuates within the corridor.
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by Thibault MERCIER