Zero hour has come as Europe's central bank cuts its rates
The sinking feeling that central banks are running out of heavy ammo was behind the global market's negative reaction to the latest round of monetary easing yesterday.
On Thursday night our time, there was central bank activity that in the past would have sparked a market rally. China's central bank cut its benchmark lending rate by almost one-third of a percentage point to 6 per cent, and the European Central Bank moved its benchmark rate down, by a quarter of a percentage point to a new low of 0.75 per cent. It also cut its deposit rate by a quarter of a percentage point to zero, and the Bank of England expanded a ''quantitative easing'' injection of cash into the British financial system by £50 billion to £375 billion ($567 billion).
Shares fell, key European bond yields rose and the euro plunged, mainly in response to the European Central Bank's moves. It was the creation of a zero per cent deposit rate that was the hot topic: Europe is ground zero for the crisis, and it is now moving into uncharted territory.
The deposit rate cut is an attempt by ECB to encourage the banks in Europe to take a bit more risk, and start lending. Its long-term bank refinancing operation swung €1 trillion of three-year money priced at the central bank's benchmark rate into European banks on either side of Christmas, but the money has so far not transmitted strongly into bank lending. Ahead of yesterday's ECB move, European banks had about €800 billion ($965 billion) parked with the central bank, earning an interest rate of 0.25 per cent a year.
You would think that's a lousy return, and you would be right, usually. It's unclear whether even cutting the deposit to zero will get the banks moving right now, however. Demand for credit is low as Europe grinds along in its sovereign debt crisis, and the inclination of the banks to lend to each other or their customers is even lower. Here's a brief statistical tour of the eurozone, one that shows how deep the hole Europe is in is.
The gross domestic product of the Euro area shrank by 0.1 per cent in first quarter of this year, and fixed capital formation - investment across the economy by both the government and private sectors in effect - fell by 2.2 per cent.
Government consumption has fallen for six consecutive quarters as nations rein in their deficits and debt loads, and private consumption has fallen by 0.7 per cent and 0.6 per cent in the past two quarters. Unemployment is at a record high of 11.1 per cent, retail sales have been declining since the beginning of last year, and consumer confidence has fallen by 15.9 per cent, 20.6 per cent and 20 per cent in the past three quarters.
Manufacturing order books have declined by 9 per cent, 14.6 per cent and 15.8 per cent over the same period.
Those are appallingly bad numbers, and the European banks are not just loathe to lend to the relatively few businesses and households who are looking for money, but are uncertain whether the loans they already made are good. They care less about maximising capital returns and more about capital preservation, and in that environment, the ECB is a obvious, even compelling bolt-hole.
With the deposit rate now at zero, the banks will earn absolutely nothing on their deposits, and their inflation adjusted return will be about minus 2 per cent. The central bank's hope is that this is enough pain to persuade them to look elsewhere, and put at least some of that €800 billion pile back to work in the economy.
The ECB boss, Mario Draghi, didn't seem confident yesterday that a sea change was in the offing, however. Recent moves by EU leaders, including the decision to send recapitalisation funding directly to banks that need it instead of through national balance sheets that were already drowning in debt, were positive, he said, but ''downside risks to the euro area growth outlook have materialised''.
Draghi said the €1 trillion ECB funding injection was never going to flow rapidly out through the banks into the economy, and pointed out that credit flows were not uniform across Europe: lending is growing slowly in the north and weakest in the south, where the sovereign debt crisis has hit hardest. He conceded, however, that several months had elapsed since the €1 trillion program had concluded, and credit growth was still weak.
''There are three sets of reasons why banks may not lend,'' he told a press conference. ''Risk aversion, lack of capital, and lack of funding. We have removed only the third, not the other two.''
That comment highlighted the intertwined toxic loop that Europe's policymakers and central bankers are attempting to unravel, and the lengths they are going to as they try.
At the press conference, Draghi was asked an obvious question: was even a zero per cent deposit rate enough to persuade the banks to redeploy their money elsewhere, and if it isn't, will the ECB risk moving to a negative rate, something the markets have no template for and could not have imagined before the crisis emerged?
So-called ''non-standard'' measures wouldn't be discussed in public, Draghi said, but the central bank still had artillery. By the end of the day, Denmark's central bank provided the exclamation mark: it moved its own deposit rate to minus 0.2 per cent.