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Stefan Wundrak

The ECB goes negative: gift or poison?

This is to be the first time one of the world's most important central banks has charged a negative interest rate on bank deposits, effectively charging the banks for putting their spare cash on deposit at the ECB, discouraging them from sitting on their cash, and hopefully spurring them to lend more to households and businesses.

Even at the height of the recession, neither the US Federal Reserve or the Bank of England levied a charge on cash received from banks. Negative rates are very rare and a sign of some sort of financial or economic stress. That certainly applies in this case, where the Eurozone economic recovery is unconvincing and risks being undermined by below target inflation.

While encouraging lending by banks and lowering the euro value are welcome to support the real economy, the distorting effect on asset prices will also increase. It was not pure coincidence that the DAX, the index of leading shares in Germany, broke through the barrier of 10,000 points for the first time in 26 years on the same day as the ECB’s announcement. The potential of European QE will further assist a financial market rally, raising questions about asset prices. Equally, with disinflation fears squeezing bond yields, the continents property investment markets are therefore set to see further inward yield shift, despite the Bank of England and the Scandinavian central banks already edging in the opposite direction.

Banks may be encouraged to increase their lending to commercial property and offer ever more competitive rates, but as regulation and the need to shrink balance sheets is pulling them in the opposite direction, it is to be expected that the prime end of the investment market will remain the foremost beneficiary, potentially pushing prime property yields to new record lows. It remains to be seen if some capital finds its way into secondary markets where a value push could be digested more healthily.

In light of Draghi’s intervention, the day of reckoning for government bond yields and prime real estate has again been postponed for a considerable time. On the flip side, it will get harder to eventually engineer a soft landing.

The chart below shows house prices across markets where low interest rates in combination with relatively healthy local economies keep propping up already high house prices (the US is for reference). A setup not too dissimilar to prime commercial assets in Europe’s top cities. In contrast to the Bank of England, the ECB has excluded mortgages from its special facilities, as this market segment clearly does not need any cheerleading. We have to hope that banks channel more money to businesses as intended by the ECB and not too much ends up in prime commercial real estate.

House price index

 

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Stefan Wundrak

Stefan Wundrak

Head of European Research

Stefan's biography