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Europe Crisis Is Resistant to Medicine of Low Rates


Mario Draghi, left, of the European Central Bank, with President François Hollande of France.
Credit Yoan Valat/European Pressphoto Agency

Rock-Bottom Rates
A measure of overnight borrowing costs in the eurozone again fell into negative territory on Monday. It had edged below zero for the first time Aug. 28.
[charts embedded]
Source: Bloomberg

By JACK EWING
SEPT. 2, 2014

FRANKFURT — It is getting harder and harder to find free parking for large sums of euros.

In a battered regional economy, the search for safety has become so desperate that some European investors are willing to pay for the privilege of lending to France — a country dealing with economic stagnation, political gridlock and a tough business climate. Investors might not expect their money to grow in France, but they trust that it won’t disappear.

The yield on French government two-year bonds turned negative on Monday, before edging back into positive territory Tuesday. Yields on some German debt, another perceived bastion of safety, have been below zero off and on since last month. In addition, banks have been willing to pay their most solid peers to store their money overnight.

This upside-down financial world, in which lenders pay borrowers to take their money, is the result of a decision by the European Central Bank in June. The E.C.B. effectively imposed a penalty on banks that park money in the central bank’s vaults. The radical move was an attempt to stoke the economy by forcing banks to lend to businesses and consumers.

But the strategy has not worked, one reason the central bank is under increasing pressure to try something else when it meets on Thursday — limited though its remaining options might be.

In many cases commercial banks, rather than feeling penalized by the central bank, have decided they would rather pay someone else to keep their money safe. They may not want to take the risk of lending to, for example, an Italian entrepreneur. Or the entrepreneurs may be too pessimistic about their business prospects to want to borrow.

The central bank’s so-called negative deposit rate has rippled through European markets, reinforced by fear that the eurozone economy is in decline and by nervousness about war, not only in Ukraine but also in the Middle East.

While some borrowers are benefiting from ultralow or even negative interest rates, it does not appear that the easy money is reaching the struggling businesses in countries like Spain and Portugal that need it most. That is why the European Central Bank may still need to do more to unlock credit to those countries and avert deflation, a ruinous downward price spiral.

“The negative deposit rate hasn’t worked so far,” said Marie Diron, a senior vice president at Moody’s Investors Service in London who specializes in economic and financial analysis. “The intent was that banks would lend on to the economy, and that’s not happening.”

Speculation is rampant that the European Central Bank will soon begin so-called quantitative easing — large-scale bond purchases intended to pump money into the economy. While most analysts do not expect the E.C.B. to announce such a program on Thursday, the central bank could signal that one is being prepared.

But because one of the goals of quantitative easing is to drive down market interest rates, it is unclear how effective E.C.B. bond buying would be. Market rates are already about as low as they can go.

“Policy options on monetary policy are maxed out,” Ulf M. Schneider, chief executive of Fresenius, a health care company in Germany listed on the blue-chip DAX Index, said in an email. “They cannot prevent economic trouble when we are facing fiscal problems in large parts of Europe, geopolitical uncertainty and poor industrial competitiveness.”

The march toward zero interest rates and below was led by the European Central Bank’s decision in June to impose a charge of 0.10 percent annual interest on money that banks keep there, in excess of the regulatory minimum amounts banks are required to keep on deposit.

There are undoubtedly some positive effects from the exceptionally low rates. Very short-term lending among banks is an important lubricator of the economy.

One widely watched benchmark, known as the euro overnight index average, or Eonia, fell to minus 0.004 percent last Thursday, the first reading below zero. The rate was most recently at minus 0.013 percent. Eonia reflects lending between banks that is not secured by collateral, so it is an indicator of how much banks continue to trust one another.

One question, though, is whether banks will bother to lend to one another when there is no return — not simply to cover short-term needs, but to engage in lending meant to support investment banking and commercial loans to businesses and consumers.

The signals so far are mixed. There was a spike in lending volume the day the Eonia rate first fell below zero, to 37.3 billion euros, or about $49 billion. But a day later, volume fell to €19.2 billion, according to E.C.B. data. Before the financial crisis began in 2008, Eonia lending sometimes topped €80 billion a day.

Some bankers are optimistic that interbank lending will recover. A banker in one particularly weak eurozone country, who declined to be identified because he was discussing confidential bank information, said that it was already much easier to find cash on the interbank market. He credited the improvement to E.C.B. policies, and said he expected interbank lending to increase in coming months.

But banks remain reluctant to lend the cash on to businesses, the banker said. Many borrowers remain too risky.

In addition, banks are behaving cautiously right now as the E.C.B. conducts what is supposed to be the most rigorous scrutiny of their books ever. The central bank is scheduled to complete the comprehensive review of the largest eurozone banks by the end of October. Lending could pick up once banks know where they stand.

There is hope, though, that another central bank measure — also taken in June — could end a long drought of credit in crisis countries like Greece, Italy and Portugal. After its June meeting, the central bank announced a program to provide cheap lending to banks, on the condition that they lend the money to businesses or to individuals.

The E.C.B. is to begin dispensing that money on Sept. 18, and most analysts expect the central bank to see how many banks take advantage of the offer before it takes any additional stimulus steps like quantitative easing.

One clear set of beneficiaries of ultralow interest rates is eurozone governments.

Only a little more than two years ago, there was fear that Spain and Italy would go bankrupt because of their rising borrowing costs. Investors now accept almost the same return on Spanish and Italian 10-year bonds as they do on United States Treasuries.

On Monday, Spain sold €1 billion in bonds maturing in 50 years at an interest rate of 4 percent. Spain plans additional bond issues later this week.

Spain and other eurozone countries are cashing in on the perception that the European Central Bank will not let them fail. That is why investors can harp about what they see as the ineffectiveness of President François Hollande of France and his Socialist government, then buy French debt at almost absurdly low rates.

“It’s a paradox,” said Christian Jimenez, president of Diamant Bleu Gestion, an asset management firm in Paris. “French debt is protected by potential action of the E.C.B.”

Mr. Jimenez added, though, that his firm was betting against French bonds in the market on the expectation rates will have to rise again. “It’s a good period for issuers,” he said, “but it’s very bad for the economy.”

© 2014 The New York Times Company

http://www.nytimes.com/2014/09/03/business/international/easy-money-failing-to-spur-turnaround-for-europe.html

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