European Central Bank imposes negative interest rates

Low inflation and a strong euro have driven the European Central Bank to impose negative interest rates.

The European Central Bank (ECB) took the dramatic step on imposing negative interest rates on 5 June.

Instead of paying out extra to banks that deposit money at the ECB, calculated according to the base rate, institutions will now actually have to pay financial penalties relative to the size of their deposit. Given the sizes of the sums involved, it is likely the move could prove very expensive for some banks.

Analysts believe there are two main reasons for introducing such a dramatic shift in policy.

On the one hand, inflation has been noticeably slack in the 18 countries that make up the eurozone, flagging below ECB’s two per cent target. Normally, the best way to boost inflation is to cut interest rates – but with a base rate already at zero per cent, ECB had nowhere else to go.

The other issue is related to lending. Across the eurozone, businesses and individuals are still finding it difficult to access credit. The ECB’s logic suggests that if banks are being charged to leave their reserves with the central bank, they will have more of an incentive to get that money out by increasing lending activity.

There’s another argument too, which comes on the back of the euro’s performance in the past few months. Essentially, the euro has been too strong for ECB’s liking, and by making it less attractive to deposit money in the eurozone it is hoping to bring about a fall in the single currency’s value. That should make eurozone goods and services more competitive internationally, giving a boost to European exports that has been sorely needed.

Even so, it’s a risky strategy for the institution, and one which may not even work. After all, there will probably be relatively few banks that do not try to pass the cost on to customers, and they will suffer with worse profitability.

Those who try to make the money back through charging negative interest themselves, or even through account charges and other such fees, might even see account holders withdrawing their cash.

But ECB president Mario Draghi has been reluctant to follow the US, UK and Japan into quantitative easing measures, and it is clear that something needs to be done to give eurozone economies a kickstart. The upshot of negative interest rates will have significant consequences for eurozone and global markets as a whole.