The ECB’s new interest rate policy – what does it all mean?

The European Central Bank has taken the bold decision to push the deposit rate from zero to minus 0.1 per cent, essentially meaning that Eurozone banks must pay the central bank to make deposits there.

 

But what does this decision from ECB president Mario Draghi mean for everyone?

 

 

The ECB’s new Targeted Long Term Refinancing Operation (TLTRO) is a scheme similar to the Bank of England’s funding for lending, but will only be available for businesses, not credit for mortgages, as the Bank’s originally was. This programme means the ECB will lend banks up to €400bn (£324.3bn) at today’s low rates, though each bank will only be able to borrow the equivalent of seven per cent of the loans they already have extended in the euro area. The lending will be done in September and December this year, and run until the end of 2018.

 

 

This is the interest usually paid to a commercial bank when it has deposited available capital at the ECB. In normal times, this rate is positive, meaning that the central bank pays the commercial bank interest. Now that it has been cut to -0.1 per cent, a commercial bank will actually have to pay the ECB a very small amount of interest. “At the last count there is still around €250bn (£202.71bn) of deposits which banks will now be penalised for holding at their central bank,” said David Owen of Jefferies International.

 

 

The big move that the ECB didn’t take was full-blown asset purchases, or quantitative easing. The Bank says it has started an “intensification of preparatory work” on this. President Mario Draghi confirmed that further interest rate cuts are extremely unlikely, meaning that QE may be the only game in town if the ECB wants to ease again. “The deluge of measures announced today makes it less likely that the ECB will embark on a broad based asset purchase programme in short order,” said Ken Wattret of BNP Paribas.

 

 

The refinancing (or refi) rate is the ECB’s benchmark interest rate, the equivalent of the Bank of England’s own bank rate. When a normal commercial bank wants to borrow money from the ECB, it can be refinanced, paying this level of interest. The rate was cut yesterday from 0.25 per cent to 0.15 per cent, the lowest it has ever been for the currency union. “A 0.1 percentage point cut in the ECB’s main refinancing rate had been more or less fully priced in since the May meeting,” said Fathom Consulting.