IMF Sees ECB Focus on More Asset Buying as Rate Cuts Near Limit

  • Further reductions could hurt bank profits and so curb lending
  • ECB should rely more on QE program to raise prices and demand

The European Central Bank may need to rely more on asset purchases for monetary stimulus as its negative interest rates approach the limit of their effectiveness, economists at the International Monetary Fund said.

While negative rates in the euro area have successfully eased financial conditions for banks and their customers -- spurring a modest credit expansion that supports growth and inflation -- they also squeeze bank profitability, Andy Jobst and Huidan Lin wrote in a blog post published on Wednesday. That risks reducing banks’ capacity to lend.

“Additional rate cuts could weaken the effectiveness of monetary policy,” the economists wrote. “Looking ahead, the ECB may need to rely more on purchases of assets.”

The ECB’s stimulus package includes 80 billion euros ($89 billion) a month of bond purchases, currently set to run through March 2017, as well as long-term loans to banks intended to spur lending to companies and households. The next policy decision is scheduled for Sept. 8.

Since the Frankfurt-based institution cut its deposit rate below zero in June 2014, becoming the first major central bank to start a negative-rate policy, economists and officials have debated how low it could go. After the Governing Council lowered the rate to minus 0.4 percent in March, President Mario Draghi acknowledged the consequences for banks and signaled that there is a limit to how far the rate can fall.

Tiering Option

In the research paper on which their blog is based, the authors identify tiering as one measure that would allow the ECB to reduce rates further while mitigating the impact on banks. That would involve exempting some cash from the negative rate -- for example by excluding 75 percent of excess reserves, similar to the system at the Swiss National Bank where the deposit rate is minus 0.75 percent.

Draghi said in March that the Governing Council discussed tiering but opted against it because policy makers didn’t want to signal that rates could go ever lower.

Sub-zero rates are sometimes necessary to bring down real borrowing costs -- nominal rates minus inflation -- that can hold back investment and consumption, according to the IMF blog. Even so, the benefits diminish over time and future lending growth may be insufficient to offset declining interest margins in some countries.

“Further policy rate cuts could bring into focus the potential trade-off between effective monetary transmission and bank profitability,” the authors said. “Focusing on asset purchases would raise asset prices and aggregate demand, while also supporting bank lending. This would also facilitate the pass-through of improved bank-funding conditions to the real economy.”

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