Will the European Central Bank do more harm than good today if it sends rates further into negative territory?

GERMANY-FINANCE-ECB
Negative rates would rationally boost borrowing – but markets aren't always rational (Source: Getty)

Simon French, chief economist at Panmure Gordon, says Yes.

A further cut to the ECB’s deposit rate should trigger a weaker euro, asset price increases and greater borrowing by firms and households. However, financial markets rarely behave rationally and such policy moves are not made in a vacuum. The ECB remains locked in battle with a raft of other central banks all prescribing similar policies for their own economies. Collectively, these actions represent a damaging race to the bottom, diminish their impact and reduce the pressure to undertake the structural reforms necessary for productivity growth. Lower rates will also impair the profitability of the Eurozone’s already weak banking sector. While few will weep at the idea of lower bank profits, Eurozone governments remain stymied by the conditions of the Stability and Growth Pact, meaning that a healthy banking sector is key to delivering a cyclical upturn in the Eurozone economy. Today should be an opportunity for the ECB to flex its intellectual balance sheet to push reforms further and faster while challenging the ideological pursuit of balanced budgets by some European governments. That it won’t further lays bare the deficiencies at the heart of the Eurozone project.

Ben Southwood, head of research at the Adam Smith Institute, says No.

Eurozone prices fell 0.2 per cent in the 12 months up to February. Professional forecasters, as measured by the ECB’s survey, expect inflation to be just 0.7 per cent over 2016 as a whole, and for prices to rise 1.4 per cent in 2017. Before the crisis, euro area nominal GDP growth – the total amount of spending in the economy – fluctuated between 2.5 and 5 per cent. Rather than closing the gap that the great recession opened up with faster post-crisis growth, the rate has only barely risen for fairly short periods since 2009. It stands at 2.9 per cent. All of this is telling us that ECB policy needs to be easier. Japan, under Prime Minister Shinzo Abe and Bank of Japan governor Haruhiko Kuroda, shows the way forward: an aggressive reflationary programme led by open-ended quantitative easing. Compared to QE, interest rate cuts are more distortionary, and less effective. But if they are the only tool the ECB is willing to use, they are its best bet.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

Related articles