On Thursday, ECB president Mario Draghi lowered the deposit rate on money parked at the ECB to -0.4% from -0.3%. Draghi also cut the main refinancing rate by 5 basis points to 0%.
How low can he go? Is there a limit?
There is indeed a practical limit to negative interest rate madness, and it’s likely we have already hit that limit. Let’s investigate why.
All hell would break loose if rates fell lower than -1.0%, and perhaps well before that. This has to do with Euribor.
What is Euribor?
Euribor is the rate offered to prime banks on euro-denominated interbank term loans. It is based on the average interest rates of about 50 European banks that lend and borrow from each other.
- 1 Month: -0.301
- 6 Months: -0.131
- 12 Months: -0.009
The above rates from EMMI Benchmarks. Rates change every day.
Every time the ECB cuts or raises rates, Euribor follows.
The same holds true in the US with the Fed. Interbank rates in US dollars are called Libor.
Anything over 100 represents negative interest rates. To derive futures rates subtract the value shown on the chart from 100. For example, in August of 2008, Euribor was about 5%.
How does Euribor place a Limit?
Millions of mortgages in Europe are based on Euribor. The vast majority of mortgage rates in Spain and Portugal are based on Euribor. A huge number in Italy are based on Euribor.
The typical mortgage loan in many Eurozone countries is Euribor plus 1 percentage point. For those on 1-month Euribor, the interest banks collect is no longer 1%. Instead, banks collect 0.70%. Servicing fees eat into that profit.
If Euribor fell below -1.0% banks would have to pay customers interest on their mortgages rather than collect interest!
This has already happened in some instances, primarily related to the Swiss Franc where rates are even lower.
Why Draghi Announced “No Further Cuts”
Low rates eat into bank profits. Such concerns place a floor on negative rates. This is why Draghi announced he is finished cutting rates.
The practical limit on negative interest rates in Europe may very well be -0.4%, right where we are now. Perhaps Draghi has a buffer of another -0.20% or so, but he is reluctant to use it.
If 12-month Euribor rates go any lower, it will affect bank profits on every Euribor-based mortgage loan. Loans based on 1-month and 6-month Euribor are already impacted.
Draghi is unable or unwilling to go further down the interest rabbit hole, but there are still lots of rabbit hole possibilities regarding various QE measures.
Corporate bonds still offer Draghi wide possibilities for more economic madness.
Mike “Mish” Shedlock
I’ll take ten million at -0.4% interest. Where do I sign? Who are we fooling?
Volkswagen needs $50 billion to pay off their bet the farm losses. Likewise Deutsche Bank and Siemens. Don’t even talk about Monte Paschi and Vatican Bank.
Wouldn’t lenders always maintain a positive interest rate in the contract to avoid paying the borrower? For example:
The interest on the loan is Euribor + 1% for Euribor > -0.9%, and Euribor = 0.1% otherwise.
Ha ha . That is exactly what Spanish banks did with their ‘contratos suelo’ which set a floor for a great many mortgages . It was taken to court , the banks lost (under EU law I think , but am not certain) and are all now happily repaying their mortgage holders the amounts they ‘overcharged’ them . So in short , no , banks cannot do this , though you would have to check if it is all banks in EU or just Spain…. just checked for you and it seems to be EU law, outdated article , but gives an idea :
No , by EU law disallowed , Spanish banks had to repay after losing case . Posted a fuller reply with link but seems held up for now.
My question was asked and answered above. In that case probably ECB’s fear would be Mortgage lending will stop altogether. Can they get it going by diktat?
Can the EU law be changed? After all, you can expect anything from these politicians…
What they have done is to relieve the average mortgage holder of several thousand euros a year in repayment. So far it is ‘temporary’, as in rates may rise again, but obviously do not look as if they will soon. New mortgage borrowing is pretty much flat, valuations are still unstable in some countries.
For fixed rate mortgages borrowers are paying 3 to 4 %, so obviously there is room there for an all out low, you could imagine variable ( many EU countries use predominantly variable rates) being transferred to fixed at near 0%, interest only options – there is a lot of rope left for financial authority to play out its social and political engineering with, to squeeze out at least some kind of return … but that is not economics really, it is playing games with an undue leverage.
Is a classic idea how CB’s can do a hellicopter drop. Just make everyone with a social security number into a chartered bank. Then loan same money at zero interest and infinite duration. Heh.
It’s kept the banks alive so far. Why not extend it to everybody?Brilliant.
“IS THERE A LIMIT TO DRAGHI’S NEGATIVE INTEREST RATE MADNESS?”
Only if it is imposed on him by others, otherwise no. The formula he follows states he must go bigger for longer if it hasn’t yet worked. Plus, and even more important, he would be ADMITTING failure if he didn’t keep going. Also, and still more important, the Eurozone is financially addicted to ECB QE, including negative rates and debt monetizaion. The Eurozone is not capable of paying its own way and living within its means. It can’t afford market rates and, as evidenced by the first Eurodebt crisis, it won’t pay them.
So, no, there will be no end to Eurozone QE or negative rates. At least, not until the Eurozone ends, which is the logical conclusion of events.
Billy Walrus said:
Draghi should continue until he makes the Euro worthless and causes revolution throughout Europe. What a moron.