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Analysis
Double edged effect of ECB move

Double edged effect of ECB move

Reaction from Germany will be crucial 

by David Marsh

Thu 5 Jun 2014

The worst aspect of today's expected move by the European Central Bank (ECB) into negative interest rate territory is this: the easing action will be the surest sign yet that the European debt crisis is not over. The second most problematic part is the ECB’s interest rate package: it will manifestly run against the interests of Germany, the euro area’s biggest economy and also the largest and most vociferous creditor.

The fear is that a cut in the headline ECB interest rate to close to zero, and a reduction in deposit rates to minus 0.25%, together with other measures to bolster liquidity and loans to smaller businesses, cannot and will not provide the massive impulse needed to return the euro area to full health. But it will none the less be more than sufficient to antagonise public opinion in Germany, given widespread aversion to low interest rates at a time when German economic growth is far higher than the rest of the euro area and savers are concerned about low returns.

The renewed fall in euro area inflation to 0.5% in May from 0.7% in April is a further spur on the ECB to take across-the-board action. But a negative reaction from Germany could pose a double problem. First, it could have a psychological effect lowering the impact of the action. Second, it may well raise anxiety that, should the ECB’s measures prove to be ineffective in stemming fears of deflation, the option of full-scale purchases of government bonds – anathema to the German government and Bundesbank – will come closer to the surface.

The Bundesbank is known to be worried that the ECB will become the first major central bank to move into negative interest rate territory, just at the time when the Federal Reserve is embarking on a slow retreat from its extraordinary monetary easing of the past five years. If European interest rates remain low or negative, and US interest rates rise faster than expected in 2015, then the US and Europe may show divergent monetary policies of the kind not seen for 20 years or more. Underlining this, Axel Weber, the former Bundesbank president, who now is chairman of Swiss bank UBS, warned this week of volatility as US and European monetary policies diverge.

Mario Draghi, the ECB president, has won acclaim with the successful but so-far-unused Outright Monetary Transactions (OMT) programme announced in summer 2012 to buy weaker countries’ bonds, under certain conditions, to shore up the euro. Many market operators believe the OMT programme has been an elaborate (and so far effective) bluff, a view reinforced by a recent statement by Wolfgang Schäuble, the German finance minister, who said bluntly in April that the OMT would never be implemented. 

Schäuble explained at a lecture in Bielefeld University, revealed by Bloomberg news agency, that, as far as decisions over OMT bond purchases are concerned, the ECB ‘cannot make these decisions because it has bound them to conditions that are beyond its control.’ Schäuble said that these conditions are decided by the European Stability Mechanism (ESM), the European governments’ bail-out programme. ‘ESM decisions are subject to a unanimous vote and we will not approve of such a programme as announced by the ECB,’ Schäuble explained – buttressing a belief that,  after a two year interregnum, euro area jitters may be about to restart.

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