Euro Macro: Fall in bank lending rates may encourage ECB to cut policy rates further – Eurozone bank interest rates continued their decline in August, suggesting that the monetary transmission mechanism is still functioning. The composite cost of borrowing indicator for corporations fell by 5bp in August, taking the cumulative decline since the start of the year to 11bp. Meanwhile, the composite cost of borrowing indicator for house purchase also fell by 5bp in August, leaving it down by 26bp since the start of the year. Banks were able to pass on lower interest rates to depositors as well in August. The composite deposit rate for corporations declined by 9bp, taking it to negative territory for the first time in history (at -2bp). Meanwhile, the composite interest rate for new deposits from households fell by 3bp (to +0.33%). Although the rate on overnight deposits remained stable at levels close to zero, banks reduced the rate on deposits with an agreed maturity of up to a year. The fall in deposit rates recently will help to mitigate the effects on net interest income of the banking sector. Though it should be noted net interest income has been on a declining trend in recent quarters reflecting the lagged effects of prior rate cuts. In particular, past ECB stimulus measures saw bank lending rates falling much more than deposit rates.
While we will need to see more data to get a clearer view on how the banking sector is responding to more deeply negative interest rates, the early signs will be viewed positively by the ECB. Although net interest income has been under pressure, banks continue to reduce lending rates to households and businesses. Meanwhile, bank lending continues to expand, though it will likely slow for cyclical reasons in the coming months. These trends should bolster the ECB’s view that the level of policy rates is not yet at the ‘reversal rate’ (when the adverse effects of negative rates outweighs the positive effects) and that it can therefore cut further. We continue to expect the ECB to cut its deposit rate by an additional 10bp. The central bank will watch the data closely beyond that point to judge whether it starting to approach the reversal rate, or whether there is more room to go lower still. Our sense is that there is not much additional room left. (Nick Kounis)
UK Politics: An October Brexit remains unlikely – The UK government today presented its detailed proposals to replace the much-derided ‘backstop’ element of the EU Withdrawal Agreement. As we had flagged, the changes essentially amount to the backstop only applying to Northern Ireland rather than the whole UK, with some twists: 1) while Northern Ireland will stay aligned to single market rules for goods, it will not stay in the EU’s customs union; as such, customs checks between Ireland and Northern Ireland will be required, with the UK government proposing that these take place away from the border at the supply chain level on business premises; 2) regulatory alignment is subject to initial approval by the Northern Ireland Assembly at the end of the transition period (end-2021), and thereafter every four years.
Deal could be reached, with modifications – The proposal shares similarities with the original backstop proposal from the EU, under which Northern Ireland would stay part of the single market and customs union. As such, we suspect the EU would want changes to the UK proposal along the following lines: 1) that NI also remains part of the customs union until ‘checks away from the border’ are proven to be sufficiently effective; 2) that the initial approval by the NI Assembly (which has been suspended for nearly three years) is bypassed, given the immediate uncertainty this would introduce to the implementation of the deal. The EU could perhaps accept the ‘approval every four years’ provision, which would essentially amount to a rolling time limit on the backstop. However, it is uncertain even with these changes whether a deal would be acceptable to both sides.
Parliamentary arithmetic is a bigger challenge – Even if a deal is reached, PM Johnson’s minority government faces an uphill struggle getting it through parliament. There are some Labour MPs who would in principle support such a deal, though many of these would balk at the idea of the current government’s stated goal of diverging from EU rules (which could lead to, among other things, a dilution of worker and/or environmental protections). Politically, it could also be more advantageous to reject a deal now and to get a Brexit delay, given PM Johnson has staked his premiership on leaving the EU at the end of October. As such, our base case remains that Brexit will be delayed, with a general election following in late November/early December (see here for more). (Bill Diviney)