“The longer [very low inflation] lasts, the higher are the risks,” Mr. Draghi (ECB President) said at a news conference. “That is what we are reacting to.”, The Wall Street Journal, June 6, 2014

“I am not saying it is wrong, but let’s be clear, many central bankers, economists, and politicians around the developed world, including ours here in the U.S., believe that it is important to create monetary inflation of around 2% a year or so, in order to foster economic growth and sustain full employment. This monetary inflation forces/or encourages consumers, businesses and even governments to buy/spend now (and not save), to borrow more, and to speculate on assets that inflate in value (like real estate). (Isn’t this essentially the opposite of what we were taught was prudent when we were kids?) There can be no doubt that the “live-for-today” (as opposed to “save-for-tomorrow”) economic culture created by inflation expectations is what most of the developed world’s central banks and politicians seek, because it’s a lot tougher to create the conditions for sustained real economic growth. But there are many consequences of this policy, both positive and negative and many unintended ones that are not well understood. For example, in the U.S. when you provide government mortgages that are low-down payment (high leverage and non-recourse), low-rate 30-year fixed-rate/fixed-payment mortgages (that do not have a prepayment penalty) and you add tax deductibility of mortgage interest, $500,000 in capital gains avoidance (every two years for a families’ residence) and then you add central bank-created monetary inflation of at least 2% a year (it’s actually averaged about 4% a year over the past 50 years), these are individually important micro-economic factors that when combined become exponentially powerful and I believe they tend to push single-family, nominal real estate values much higher than they otherwise would be (a negative for the young adults, the poor, and future generations who are shut out of housing, as a result). I also believe Fed-created inflation expectations and these factors are one of the primary causes of over-exuberance/irrational behavior (think unsustainable bubbles) in single family real estate, we now seem to be experiencing with more frequency.”, Mike Perry, former Chairman and CEO, IndyMac Bank


Ailing Europe Tries Below-Zero Interest Rate


Updated June 6, 2014 12:01 a.m. ET

FRANKFURT—The European Central Bank took extraordinary steps Thursday to stave off the threat of dangerously low inflation in Europe, including cutting a key interest rate below zero for the first time in a bid to get banks to lend more to credit-starved customers.

But the bank stopped short of more drastic measures it has considered, such as the kind of asset purchases employed in recent years in the U.S. and U.K.—both of which are now doing better than the euro zone. That led some investors to question whether the ECB had gone far enough, and markets only briefly reacted. Bank President Mario Draghi himself indicated the bank may need to do more to protect the region’s fragile economic recovery.

“Are we finished? The answer is no. If need be, within our mandate, we aren’t finished here,” he said, adding that broad-based asset purchases remain an option.

The lack of a strong market response stands in sharp contrast to July 2012, when Mr. Draghi’s pledge to do “whatever it takes” to preserve the euro touched off a lasting rally in southern European bond markets.

The promise then of unlimited money to buy government bonds if needed impressed investors so much, the ECB hasn’t even had to use it. But now the ECB is having to demonstrate how far it will go to combat weak inflation.

Thursday, the ECB cut interest rates and said it would make, for a start, up to €400 billion ($545 billion) in cheap loans available to banks later this year—providing they lend more to the private sector. The lengthy four-year maturity on the loans is another first for the ECB, and underscores the worry that sluggish consumer prices and falling credit could create a self-feeding spiral, depressing wages and job creation as well.

The stimulus package came two days after a report showed that annual inflation in the euro zone weakened to 0.5% in May, below the bank’s target of just under 2%. Some economists expect inflation to fall further this summer.

“The longer [very low inflation] lasts, the higher are the risks,” Mr. Draghi said at a news conference. “That is what we are reacting to.”

The euro fell to a fresh four-month low of $1.3503, from just above $1.36, but later erased all the day’s losses. The ECB says it doesn’t target the exchange rate but has warned that the euro’s recent strength is contributing to weak inflation.

European stocks surged to a 6½-year high, led by a steep rise for banking stocks, before giving up part of their gains.

Marco Tronchetti Provera, chairman of Italian tire manufacturer Pirelli & C. SpA, said the measures should help sentiment. “It’s not so much the size of the cuts, but the fact that the ECB has indicated it will act. It’s an important sign,” he said.

The ECB “has thrown in the kitchen sink to signal this is an empathic response,” said Ken Wattret, economist at BNP Paribas. Nevertheless, he added, “I’m not convinced this will be sufficient to alter the trajectory of inflation.”

The ECB’s efforts come as much of the world struggles to lift growth five years after the global recession ended. The U.S. recovery stands as one of its weakest on record. China is trying to prevent deeper trouble from its property bubble. And other pockets of the world are weighed down by conflicts, from the Russia-Ukraine standoff to postrevolution turmoil in the Middle East.

Even with Thursday’s rate cuts, ECB policy remains tighter than the Federal Reserve’s. Because annual U.S. consumer-price inflation is higher—at around 2%—that means interest rates, after being adjusted for inflation, are significantly lower in the U.S. than they are in Europe.

That gives U.S. consumers, businesses and the government an edge when it comes to servicing their debts.

The longer-term worry, for both Europe and the world economy, would be if low-to-no inflation becomes entrenched in the euro zone, leaving it indebted and sluggish even in upturns.

Some economists say the euro zone is at risk of turning into a bigger version of Japan, which suffered from stagnation and low price expectations for two decades, even if most European countries avoid outright deflation.

Even Japan has started to see steady increases in consumer prices, as has the U.S. Their central banks have been far more aggressive than the ECB, largely by purchasing huge amounts of public and private debt to reduce long-term interest rates.

Mr. Draghi said the ECB’s governing council will intensify its preparations to buy asset-backed securities, or bundles of bank loans. However, the start date is unclear and will likely require a minimum of three to six months of preparatory work, assuming it decides to pull the trigger.

The entire 24-member governing council approved Thursday’s package, meaning Germany’s conservative central bank signed on despite its opposition to previous steps the ECB has taken during the debt crisis.

Bundesbank support provides cover for Mr. Draghi in Germany, where aggressive easing of monetary policy is typically viewed with skepticism.

The interest-rate cuts and bank loans that the ECB put in place are variations of tools it has used before—with little success.

The ECB cut its main lending rate to 0.15%, a record low, from 0.25%, meaning commercial banks in Spain and elsewhere in the euro zone can borrow more cheaply from the central bank. It also cut the rate on bank deposits parked overnight with the central bank to minus 0.1%, from zero, thereby charging commercial banks for keeping their money at the ECB.

Though it is a small cut, the negative rate carries symbolic importance and makes the ECB the largest central bank to go this route.

Sweden and, more recently, Denmark have experimented with negative deposit rates in recent years, with mixed results. Some banks may just pass the cost on to customers, rather than increase lending.

“For all practical purposes, we have reached the lower bound” on official interest rates, Mr. Draghi said, indicating it was probably done on that front.

He said the ECB will make additional loans available to banks at attractive rates, starting in September. If banks don’t prove they are boosting lending to the private sector, they will be forced to repay the loans early.

However, previous attempts to spur lending didn’t have much success at stimulating the economy. The ECB lent banks over €1 trillion in three-year loans in late 2011 and early 2012 without conditions, but lending to the private sector has been shrinking in recent months. Banks have instead been repaying the ECB early.

The ECB also suspended its weekly absorption of bank funds—called sterilization—under a previous bond-purchase program, which may add up to €165 billion of funds to the banking system.

French President François Hollande, whose government has pressed the ECB to do more to stimulate the economy and weaken the euro, applauded the moves at a news conference after a meeting of the Group of Seven leading economies in Brussels. “I should salute the decisions the ECB has taken,” he said.

But Guntram Wolff, director of the Brussels-based think tank Bruegel, said they were missing two elements: measures to boost inflation in Germany and France, the euro zone’s biggest economies, and more aggressive steps that weaken the euro.

“It’s not something that will change inflationary dynamics as a whole,” he said.

—Marcus Walker and Christopher Lawton contributed to this article.

Copyright 2013 Dow Jones & Company, Inc. All Rights Reserved
This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit

Posted on June 6, 2014, in Postings. Bookmark the permalink. Leave a comment.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: