On Thursday we are expecting to see a further dip into the icy-cold world of negative interest-rates made by the European Central Bank. After all the hints and promises made by its President Mario Draghi its deposit rate is expected to fall from the current -0.2% to either -0.3% or -0.4%. Also the negativity if I may put it like that will be reinforced and backed up by an extension to the Asset Purchase Program or QE via an extension beyond next September and/or a faster rate of purchases. These expectations have seen an extension to the negative interest-rate environment already.
If we look at bond yields we see that the two-year yield in Germany has fallen to -0.42% predicting a cut to -0.4% if it is right. However more remarkable is the way that five-year yields in France are dipping in and out of negative territory and the same for the two-year yields of Spain and Italy. So we see a litany of markets where price discovery has been abandoned as a method of determining economic reality and instead they depend on the cheque book of the central bank.
On Thursday if Mario Draghi carries out his hints and promises we will see the ECB take the Euro area further into the world of negative interest-rates and I mean this in terms of amount and length of time. What impact will this have?
Is it necessary?
There is a real problem here as this morning we have seen data which suggests that the Euro area economy if not surging is doing okay. For example there was this from Germany.
In October 2015, roughly 43.4 million persons resident in Germany were in employment….. Thus employment surpassed the record high observed in September 2015 since German reunification.
Employment has been a leading indicator in the credit crunch era ( in the UK for example) but you could argue Germany is a special case. But there has also been this for the whole Euro area from the Markit PMI.
The eurozone manufacturing upturn gained further momentum during November, with rates of expansion in production and new orders the fastest for around one-and-a-half years. Growth was broad-based by country, with output and new business inflows improving in almost all of the nations covered (the exception being Greece).
As monetary policy is already very expansionary then the ECB seems set to make a policy error on Thursday. If recent speeches are any guide it will claim that the improvement is due to its policies (skipping over the oil price fall) and point us towards inflation being below target. It may even highlight the -0.4% CPI inflation reading in Italy.
Sweden is an example
If we look to see what negative interest-rates can do in an environment of falling oil and commodity prices let us look yesterday’s development in Sweden.
Sweden’s GDP increased 0.8 percent in the third quarter of 2015, seasonally adjusted and compared to the second quarter of 2015. GDP increased 3.9 percent, working-day adjusted and compared to the third quarter of 2014.
This would in the past have a central bank looking for the punchbowl so they could take it away but of course the Riksbank has its foot firmly on the accelerator as it indulges in pro rather than anti cyclical policy. If life was that easy then central bankers would be found permanently on the beach or ski slopes before we realised we could just open the taps permanently and fire them. The catch? Here is a clear example if we look at private-sector debt.
Most of the increase can be explained by housing loans, which increased by SEK 196 billion and amounted to 2 655 billion in total in October. Housing loans had an annual growth rate of 8.1 percent in October, which is an increase compared with September when the growth rate was 8.0 percent.
The consequence of this for house prices can be filed under this from the Black Eyed Peas.
Boom boom boom (Gotta get get) [x4]
Boom boom boom (now) [x2]
Boom boom boom [x2]
House prices in Sweden have risen by 2% in the quarter to October and by 10% on a year before with a few districts in Stockholm rising at over 20% annually. If we look back we see that house prices have reached “escape velocity” since the Riksbank started cutting interest-rates. The house price index of Sweden Statistics was 492 at the end of 2007 and was 668 at the end of the third quarter of 2015. What credit crunch house prices might say?!
Is that what the ECB is aiming for in the Euro area where debt both private and public sector is compared to assets (house prices) more favourably? My argument which I am sure that prospective house buyers in Sweden will agree with is that would be misrepresenting inflation and is we allow for that more accurately a lot of the recorded economic growth fades away.
How did a housing boom work out for Spain and Ireland in particular?
Interest-Rates for the ordinary person
These have not turned out to be as expected or hyped. Let me give you an example from Statistics Sweden to illustrate this.
The average interest rate for housing loans for new agreements was 1.59 percent in October, which implies that it increased compared with September when the average interest rate was 1.58 percent.
Whilst there may be an occasional example of negative mortgage-rates, for example ones set in relation to official rates as happened in the UK, they are still a fair way away overall. So much lower but not negative is the message here.
In the world of savings and in particular bank deposits then negative interest-rates were assumed to be something that would be passed on very quickly. But in fact banks have generally avoided this. For example I have just been searching in Sweden and if the online tables are up to date you can get 0.3% for a year with Nordea Bank. Not much but also not negative.
However “the times they are a-changing”. Remember this that I pointed out on the 19th of October?
From the first of January, customers of the Alternative Bank Switzerland ABS will not only get no interest, they have to pay even itself 0.125 percent interest that they may give their money to the ABS.
A small Swiss bank is dipping its toe in the water of negative interest-rates for savers and depositors. Interestingly quite a few places have been reporting this as news in the last week or so which puts them more than a month behind us and in the category of slooooow news.
What we take forwards from this is that it takes at least a year for the impact of negative interest-rates in the wholesale and money markets to reach the ordinary person. That year is only seeing a dipping toe rather than a wide scale move. Maybe that will change should we see more countries dragged into the supermassive black hole that is negative interest rates but as we muse on the subject that is the evidence so far.
There are various lessons to be learned from the negative interest-rate experience so far so let me explain them. Firstly dips into the pool seem to create the demand for further reductions as we hear Agent Smith calling for “More! More!”. Secondly no-one has yet escaped from it and I am thinking of Sweden here as you might think that an annual growth rate of nearly 4% would provide such an opportunity. Thirdly the danger is of overheating private credit and loans leading to a house price boom. Fourthly there is the oddity of such a policy being pursued when the outlook for the countries concerned was already being boosted by lower oil and commodity prices. This makes us wonder if genuine economic improvement is what is being planned or not? So in summary we turn to Coldplay.
Oh, no, I see
A spider web, and it’s me in the middle,
So I twist and turn,
Here am I in my little bubble,
For the man and women in the street then negative savings and deposit rates have in general not occured and I think the banks are afraid of what would happen. However as time passes that will change and the negative interest-rate sage will take another dark turn.
Meanwhile there is another feature which is geographical and that is that the countries afflicted are in or near to the Euro area. Even the IMF seemed to abandon its “on track” methodology yesterday as in essence adding the Chinese Renminbi to its Special Drawing Rights saw quite a reduction for the weighting of the Euro.