ECB View: Indicators suggest policy rate still above the reversal rate – The ECB’s journey to a more deeply negative policy interest rate in September of last year has triggered debate about whether the ‘reversal rate’ has been reached or at least is in sight. When interest rates are reduced to very low and usually negative levels, they can reach a rate that weighs on the economy rather than stimulates it. This can happen because bank margins come under such pressure that banks tighten lending conditions by making bank loans less available and/or more expensive. An alternative channel is that households save more rather than less as they attempt to hit the same future savings target despite lower interest rates on their deposits. Finally, if too low interest rates undermine financial stability, this could also sow the seeds for future negative forces on demand. In today’s note, we focus on the bank lending channel.
Recent trends in bank lending rates, lending volumes and lending standards suggest that the reversal rate has not yet been reached. Bank lending rates continue to fall. In the year to December, the composite lending rate to companies fell by 8bp, while the composite mortgage lending rate fell by 39bp. Since the ECB’s deposit rate cut in September of last year, corporate lending rates are broadly stable, while mortgage lending rates have continued their downward trend.
Meanwhile, bank lending volumes have continued to expand. Annual growth in loans to households (adjusted for sales and securitisations) increased by 3.7% in December, up from 3.5% in November, driven by robust growth of loans in the form of both consumer credit and mortgages. In contrast, loan growth to non-financial corporations is clearly slowing. It eased to 3.2% from 3.4% in November and 3.8% in October. Monthly flows are still positive, but very modest and suggest the downward trend in annual loan growth has a way to go. Nevertheless, we do not see the weaker trends in corporate loan growth to be a reflection of bank retrenchment due to pressure on margins. This is because the ECB’s Bank Lending Survey does not signal that banks are tightening lending standards, but rather that corporate loan demand has fallen. This suggests that we are witnessing a cyclical demand-side phenomenon rather that restrictions on the supply of credit.
All this suggests that in terms of the banking channel, the ECB has not yet reached the reversal rate and there is room for it to cut its policy rate further. There is a caveat however. The impact of negative interest rates on banks build over time, while the positive effects tend to ease off over time. Net interest income will see increasing pressure as old loans mature and new ones are issued at lower rates. In addition, the positive effects on bank profits of asset revaluation will fade. So although the central bank most likely has room to cut further, there are reasons to think that the room is limited. (Nick Kounis)