Central Bank governor Philip Lane has signalled that the quickest way to return to normal higher interest rates is through "forceful" central bank action now to suppress borrowing costs and stoke inflation.
As economists debate whether current low-interest rates will prompt people to take excessive investment risk and sow the seeds for another crisis, Mr Lane said the more quickly inflation, running at 0.2 per cent in the euro area, returns to the European Central Bank’s 2 per cent targeted rate, the sooner policy rates would “renormalise”.
Addressing the New York University Stern School of Business on Tuesday, he said: “Put differently, forceful accommodative monetary policy in the short run is the best method that policy rates do not stay low for longer than is necessary.”
The ECB’s governing council cut its main interest rate to zero in March and is in the middle of a €1.7 trillion bond-buying programme to boost the economy and inflation across the euro zone, following the financial crisis. Meanwhile, the rate that banks receive for deposits lodged with the ECB is -0.4 per cent, meaning they are paying the central bank for the privilege of holding their money.
“If warranted, the governing council will act by using all the instruments available within its mandate” to boost inflation, Mr Lane said.
Meanwhile, the governor said that an assessment of the ECB’s negative deposit rate should look closely at its impact on the banking system, as it may impact their profitability and ability to generate capital and increase lending in future.
Excess reserves
“Of course, those banks that hold excess reserves face a direct cost from the negative deposit rate,” he said. “In addition, to the extent that banks cannot pass through the lower rate to all types of depositors, the net interest margin of banks is also compromised if competitive pressures mean that lending rates fall by more than deposit rates.”
On the other hand, lower rates make it easier for borrowers to repay their debts, he said.
In addition, as market interest rates, or yields, on bonds have fallen as a result of central bank action, banks are able to book capital gains as the value of their bond investments rise, he indicated.
