ECB to use a negative interest rate

The Swiss franc (CME:S6M14) was little changed against the euro (CME:E6M14) after the European Central Bank unveiled an unprecedented round of measures, taking pressure off the Swiss National Bank to step up the defense of its its currency cap.

The ECB, led by President Mario Draghi, today became the world’s first major central bank to use a negative interest rate, making good on its month-old pledge of action to prevent deflation. The Frankfurt-based institution announced a cut in its deposit rate to minus 0.1% from zero.

“A lot was priced in, so for the SNB this is having little effect, said Maxime Botteron, economist with Credit Suisse Group AG in Zurich, adding he didn’t expect the Zurich-based central bank to charge banks on their deposits. ‘‘So long as the franc holds above the 1.20 they won’t do anything.”

The franc traded at 1.2187 against the 18-nation currency at 4:11 p.m. in Zurich. Against the dollar it traded at 89.73 centimes.

In a bid to get credit flowing to parts of the economy that need it, the ECB also opened a 400-billion-euro ($542 billion) liquidity channel tied to bank lending and officials will start work on an asset-purchase plan.
 

Differing Views
 

Ahead of today’s decision, economists were split on whether the SNB would take action in response to the ECB, with 11 out of 21 in a Bloomberg News survey last month saying it would. Of those, seven said policy makers would sell francs against the euro for the first time since September 2012. The rest said they could charge banks for excess sight deposits.

“Our central case is that they’ll maintain the floor,” said David Tinsley, economist at BNP Paribas in London, adding the SNB would be prepared to “intervene aggressively” to maintain it. “In an adverse scenario, there’s more they can do, for sure.”

The International Monetary Fund suggested on May 28 the SNB could consider charging banks for surplus funds held at the central bank to discourage franc demand.

The SNB set the minimum exchange rate against the euro in September 2011 to protect the Swiss economy from the risk of deflation and a recession after haven flows pushed the franc nearly to parity with the euro. The SNB bought large amounts of euros to defend the cap, leading its foreign currency reserves to swell to 70% of annual economic output.

The ECB’S announcement of a bond-buying program in September 2012 took pressure of the franc and has meant that the SNB hasn’t had to intervene in currency markets to protect the ceiling since then.
 

High Hurdle
 

According to Dirk Schumacher, a Frankfurt-based economist at Goldman Sachs Group Inc., the hurdle for the SNB charging banks for their excess deposits is high, “given the very easy domestic financial conditions,” he said in a note to clients yesterday.

Even with the minimum exchange rate, consumer prices are set to stagnate this year, with inflation accelerating to 0.4% in 2015. The central bank forecasts economic growth of 2% for 2014.

As for the SNB, its officials have stressed they are prepared to take further steps to defend the cap if necessary. SNB Governing Board Member Fritz Zurbruegg said in March that from an ’’operational point of view’’ the Swiss policy makers were ready to use negative interest rates if so required.

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