Draghi’s negative interest rates help Eurozone’s cohesion

European Central Bank Press Conference – 6 June 2019, Vilnius, Lithuania. Mario Draghi, ECB President (in the middle), Vitas Vasiliauskas Chairman of the Board, Lithuanian Central Bank (on the left) and Christine Graeff, ECB Director General, Communications, (ECB photo, some rights reserved).

Super Mario did it again. Only months before leaving the helm of the European Central Bank he made sure his accommodative monetary policy will hold well, even after he leaves Frankfurt am Main. Last Thursday, he pushed interest rates below the zero level for at least another year. Even if his successor will be a hawk supporting restrictive policies, it will be very difficult to start paying interest rates to German pensioners’ bank deposit accounts.

Speaking to journalists after the last ECB Governing Council meeting in Vilnius, Lithuania, Draghi was adamant: “For banks whose eligible net lending exceeds a benchmark, the rate applied in TLTRO III will be lower, and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation plus 10 basis points”.

Negative interest rates

After recently introducing the ‘targeted longer-term refinancing operation III’ for banks or TLTRO III, now he and the Governing Council decided that the ECB will actually pay its borrowers. This is because ECB’s “average interest rate on the deposit facility” is currently at -0.40%. Add to that 10 basic points of interest and you end up with -0.30%. In other words, at the end of loan’s maturity, the borrower will return to ECB 0.30% less than what was initially received. To be noted, only the banking industry, aka the commercial banks, can borrow from the ECB.

There is more to it though. A commercial lender, the moment it asks and receives the loan from the central bank, can lock the negative interest rate prevailing at the moment of receiving refinancing, aka loan. Draghi clearly explained that the interest rate of the loans will continue “prevailing over the life of the operation” because it falls in the TLTRO III program, introduced by the ECB some months ago. Now, however, the interest rate the banks are going to pay won’t be a flat zero but in fact a clearly negative -0.30% or a gift for ‘choosing us to get you billions’.

Supporting growth

Of course, Draghi is not simply a benefactor of the euro area banking industry. He really aims at further cutting down the interest rate costs paid by the over-indebted governments of Eurozone, when refinancing their maturing debts. Surprisingly enough, at the moment the governments of Greece and Italy, the two most over indebted countries of the 19 member euro money area, pay for their borrowing less than the United States, a country which has never defaulted on her debts. This must be exclusively attributed to ECB’s extraordinary measures.

For example, last Friday, Greece’s ten year government bonds were traded at yields well below 3%, while the US government pays for its new ten years bond issues around 3.5%. Italy borrows at even lower interest rates, while the German ‘bunds’ are at times traded much above par at negative yields. During the past few days, investors from all over the world flocked to Eurozone’s capital markets, pressing European government bond prices yet higher and yields lower.

Obviously, Draghi aims at supporting the languishing again euro area economy. Last month, inflation, and growth together, took a dive again. He explained: “Despite the somewhat better than expected data for the first quarter, the most recent information indicates that global headwinds continue to weigh on the euro area outlook”.

Interest rates may fall further

For this reason, the ECB is pressing its interest rates not only to the negative region but: “Looking ahead, the Governing Council is determined to act in case of adverse contingencies and also stands ready to adjust all of its instruments”. In short, ECB’s interest rates may fall further down the negative part of the chart “in case of adverse contingencies”.

Understandably, Italy and Greece are more in need of lower interest rates than Germany and Holland. Nevertheless, the lower the cost of money, the better for economic growth all over Eurozone. As Draghi puts it, the ECB is determined “to maintain favorable liquidity conditions and an ample degree of monetary accommodation”.

This is Draghi’s way to help Eurozone to maintain coherence. However, for many years now the German hawks have been pressing for less accommodating monetary policy. So, for a good reason, they can be rightly accused of not caring about cohesion and growth for all 19 member states of Eurozone. This is a strong proof that Germany, despite being an economic giant, remains a political dwarf.