ECB President Draghi Cautiously Advocates Ultra-Low Rates as Costs Mount

The European Central Bank doesn't expect to start wrapping up its massive stimulus package by spring 2017 as the accommodative monetary environment has seemingly exhausted its potential to spur growth; however, for now, negative rates remain a grim reality.

Kristian Rouz – The European Central Bank’s (ECB) President Mario Draghi discussed his ultra-accommodative monetary policies in a speech in Berlin on Tuesday.

He relayed that although the regulator is aware of the risks and downsides of low rates, the 2pc inflation target must be met in order to ensure sustainable economic expansion. The damage to households caused by the low rates has been negligible, Draghi argued, and the ECB is adamant about pursuing its current policies in the foreseeable future.

The Eurozone is a low-rates environment, with negative interest rate policies (NIRP) intact. Commercial banks are being charged for reserves deemed as excessive; this is impairing saving strategies in household finance planning, while promoting borrowing and spending. NIRP benefits stockholders and real estate owners, but hampers pro-growth structural reforms in the economy and prevents fiscal consolidation, resulting in ballooning debt-to-GDP ratios here and there.

Draghi, however, said the negative effects of NIPR are hardly as dramatic.

"We would certainly prefer not to have to keep interest rates at such low levels for an excessively long time, since the unwelcome side-effects may accumulate over time," Draghi said. “We remain committed to preserving the very substantial degree of monetary (easing) which is necessary,” he added.

The current volume of stimulus in the form of asset purchases by the ECB stands at $1.86 trln, and Draghi’s message stirred frustration amongst investors: the ECB President did not confirm that stimulus would expand anytime soon. The ECB is buying 80 bln euros worth of fixed-income assets every month, and the entire QE program ends within five months. Observers have alleged the regulator might wrap up its ultra-loose stimulus as inefficient in propelling growth.

Another reason the ECB might start scaling back its stimulus efforts is that the amount of assets eligible for being bought out is being exhausted in Germany, while in other parts of the Eurozone, the ECB has almost bought everything it could under the program. While the issue of liquidation of these assets is coming to the forefront, opportunities for further purchases are restricted.

Therefore, the ECB might cut rates deeper into negative territory. Draghi’s commentary largely supported the view.

“The household sector, often thought to have lost out the most in Germany due to its large net saver position, has in fact only recorded a mild loss in net interest income,” he said.

Besides, the weaker euro – thanks to the loose monetary conditions – has helped European exports, keeping jobs in place, Draghi added.

"Certainly, some savers might suffer from a temporary period of low interest rates, especially if they rely on interest income and cannot smooth their consumption through credit," he said. "But whatever financial assets savers hold, in the final analysis their return always depends on the growth rate of the economy."

The ECB might cut its deposit rates by another 0.4pc, thus lowering the rate to —0.5pc, slashing the profitability of commercial bank operations, and charging a de-facto tax on savings accounts.

Apparently, higher rates of economic growth and job creation are a broader policy objective, but the policy measures undertaken in real-time are affecting the lives of millions instantly, while the effects of these policies are rather distant and uncertain. Hardly any safeguards exist against policy failures, which NIRP might eventually prove to be.

Draghi advised that NIRP isn't the "new normal," adding that  "we will get out of these measures when price stability has been reached in a sustainable way without the extraordinary monetary support of today."

Meanwhile, German Finance Minister Wolfgang Schaeuble aligned himself with the German savers, responding the Draghi’s claim that Germany could “do more” for the Eurozone to enhance demand, investment and productivity, supporting the ECB’s measures rather than fighting them.

“Monetary policy has been pushed to the edge of its powers,” he said, adding that international money liquidity and indebtedness have surpassed the acceptable level.