European bank shares popped in the wake of comments from European Central Bank President Mario Draghi and Chief Economist Peter Praet at a conference in Frankfurt last week indicating a willingness to consider “tiering” the ECB deposit interest rate to soften the blow of prolonged negative rates on the banking sector.
*** Tiering rates will be raised at the upcoming Governing Council meeting on April 10, but with the uncertainty of Brexit looming just ahead and no strong consensus yet on the need for it, no decision will be made then. It will be studied and kept in reserve either to be rolled out with a new TLTRO-3 program, or perhaps even later in the year, if and when Draghi may need to extend forward guidance on negative rates beyond the end of 2019 and well into 2020. ***
*** If there is a sharper than expected slowdown, neither a new TLTRO nor measures to ease the transmission mechanism of policy from banks to the economy through a tiered deposit rate will suffice, and the ECB will choose among other “break the glass” options. But that sort of slowdown is not the base case, which is of a second half stabilization after a near brush with recession in the first half of 2019, and the biggest assist the ECB is looking for now is on the fiscal side, with hopes growing all-around for an up to 1% of GDP stimulus from Berlin. ***
The Tiering of Bank Deposit Rates
While we have known that the leadership of the ECB has been mulling the pros and cons of tiering the negative deposit rate since early this year (see SGH 2/11/19, “ECB: Taking Stock of Ammunition”), a tiering of rates is not yet a done deal and still appears to be under evaluation by the leadership and technical staff as a contingency policy option if and when needed, albeit an increasingly probable one.
It is likely to be raised at the upcoming ECB Governing Council meeting on April 10, but there will be no extensive deliberations or decision on tiering made at that point, nor will there be a decision on any other policy option on the eve literally of a critical decision point in the two-year long Brexit drama that could result in a binary set of outcomes for the Eurozone economy.
Under the more benign ECB base case scenario where Eurozone growth averts dropping below zero, even if barely, and stabilizes into the second half of the year, a tiered deposit rate structure could be rolled out under one option in parallel with the newly revised TLTRO3 liquidity operations for banks — for example, from what we understand, as an alternative for banks who do not choose to draw down from the TLTRO but would still like to pay less for deposits.
Under another option, a tiered rate structure could be held in reserve for even later, close to the end of the year, and of Draghi’s tenure as President, to ease the blow on banks were the current time-contingent forward guidance on keeping rates at the current -0.4% level “at least through the end of 2019” need to be extended further and into 2020.
And in the meantime, it appears that a few influential members of the Governing Council are not yet entirely sold on the idea of tiering deposit rates to help the banking sector, including among concerns doubts about the effectiveness of instituting a policy option that has, if anything, proven to be of marginal benefit in countries where it has been adopted such as Japan, Switzerland, and Denmark. The politics of adopting a subsidy for banks, even a minor one, in the Eurozone could also be problematic at a time when the number one and two banks in Germany are about to be forced into a merger by Berlin.
And it has not gone unnoticed that Francois Villeroy de Galhau, Banque de France Governor and candidate for the succession to the ECB Presidency, who has been by far the most vocal proponent of helping banks through tiered deposit rates, was a banker himself in a previous life, and that the handful of banks who dominate the French banking system have long complained that they have had to pass slightly higher rates onto their customers than their rivals.
In the end, pragmatic concerns will prevail, and the tiering of rates is just a minor step in cushioning Eurozone banks. Were the Eurozone economy to truly need another dose of stimulus, there are other, more aggressive “break the glass” options the ECB would consider.
Break the Glass Options
Stressing that these policy measures still remain far from the Governing Council’s base case, “break the glass” options would include a resumption of the Asset Purchase Program, but this time focused on securities targeted more directly to the economy.
In practice, that would mean a low likelihood that the self-imposed and strained caps on sovereign bond purchases would be revisited, with all the legal challenges that would surely rekindle; instead the purchases would be increasingly focused on corporate debt, and, perhaps more effectively, on bank loans packaged into acceptable credit quality tranches that would be put into blind trusts so as not to violate the ECB’s dual role as monetary policy steward and banking supervisor to the Eurozone.
Despite rumors to the contrary, we detect very little interest or appetite in the ECB even if a new APP were required to wade into the socially controversial area of equity purchases like their colleagues in Switzerland and Japan have – with enormous risk and questionable success.
And of course, were it to be needed, a side benefit of tiering deposit rates would be that rates could be cut even deeper into negative territory with less regard for harmful side effects, lowering, in practice, the “Effective Lower Bound” for the ECB.
Eyeing Fiscal Help from Berlin
In the near term, and more to the point, the ECB, and even their traditionally more conservative colleagues down the street at the Bundesbank, are eyeing the political debate in Germany and hoping for some signs of an additional fiscal tailwind out of the Grand Coalition government of Chancellor Angela Merkel’s Christian Democrat/Christian Social Union and the center left Social Democratic Party.
The bottom line is that the neutral fiscal stance across the Eurozone has already turned into a modest tailwind, and chances are high that this stimulus will be boosted a bit more when the dust settles on the internal party squabbles in Berlin.
After years of strong revenue growth, Germany ended 2018 with a 1.7% of GDP budget surplus, and even though that revenue growth is expected to slow this year, expectations are that accompanying transfer spending increases, and some potential but more controversial tax cuts will take the surplus down to around 1% this year, and close to zero in 2020/21. Incidentally, that 1.7% number breaks down into roughly half under central jurisdiction, and the other half under Germany’s federalized social security/regional jurisdiction.
With German industry already operating at close to capacity utilization, despite some cyclical cooling, the argument for a corporate tax cut is politically controversial, and its merits less clear on a strictly economic basis. On the other hand, other developed countries have been cutting their corporate taxes already, and Germany now finds itself suddenly and strangely at a bit of a global competitive disadvantage on that front.
The tax driven stimulus is focused at present on two fronts: the first is in accelerating the already approved halving of the “solidarity tax” that has been in place since the reunification of East and West Germany, and second, a discussion is also underway of a potential tax exemption for the lower and middle classes that could add as much as 0.5% to GDP, albeit not until 2021.
There is also growing talk about the merits of the “Schuldenbremse” (debt ceiling), a newly established (2009) constitutional guarantee that government debt is a no-go unless under a state of national emergency/crisis. Diverse constituencies from leading economists to trade unions as well as the German Business Confederation’s Head of Economics are all calling for a revision of that restrictive provision, and for that investment impasse to be also addressed as a legal option to ditching the famous Black Zero (Schwarze Null) balanced budget pledge. Budget Committee representatives are against that relaxing of the fiscal fist … but it is telling that no senior politician has voiced their opinion on that so far.
In these efforts, the coalition will encounter little if no resistance from a Bundesbank that since the 2012-13 fiscal crisis has evolved into a far more flexible and accommodative central bank than generally presumed – witness the assumption even if initially begrudging of the Asset Purchase Program, Negative Rates, and their part just now in the unanimous agreement by the ECB Governing Council to a time-contingency including forward guidance that locks negative rates into 2020.
Indeed, it is both Bundesbank and ECB officials that are hoping, against hope, their efforts at accommodation will be accompanied now, finally, by a roughly 1% of GDP stimulus from Berlin.