Low interest rates may go even lower

THE EUROPEAN Central Bank continues to ease monetary policy as part of efforts to boost economic growth and drive inflation up.

(Source: Sme)

While the opinions of economic and bank analysts differ over whether this is the best cure, already-low rates in Slovakia are set to fall even further.

“Inflation has not been developing in line with the original expectations of the European Central Bank; it was even negative in February,” analyst Kamil Boros of X-Trade Brokers told the public broadcaster RTVS. “This means that the eurozone was in deflation. But this is a situation when the European Central Bank tries to stimulate demand for loans and it is doing so in a way that it cuts interest rates for banks so new loans are cheaper.”

Bank analysts assume that the reduction of rates might bring another decline in interest rates in banks.

“In combination with the pressure of regulation and competition the chance for low or even lower rates will increase, on deposit as well as credit products,” said ČSOB analyst Marek Gábriš. “But this probably will mirror in profitability and can lead to the departure of some players from the market.”

A wave of mergers would await us within some time on the European market too, added Gábriš.

The European Central Bank (ECB) cut its main interest rates as well as expanding its bond-buying programme.

“This comprehensive package will exploit the synergies between the different instruments and has been calibrated to further ease financing conditions, stimulate new credit provision and thereby reinforce the momentum of the euro area’s economic recovery and accelerate the return of inflation to levels below but close to 2 percent,” said ECB President Mario Draghi on March 10 as cited by Reuters.

Katarína Muchová, analyst at Slovenská Sporiteľňa, wrote in her memo that while the ECB was not reluctant to use several measures from its arsenal of instruments at once, “President Draghi stressed again the need of fiscal and structural policies in individual countries of the eurozone as the monetary policy needs support also from these fields to boost the growth”.

The ECB on March 10 launched a package of measures to stimulate the eurozone economy and boost inflation. Within them it cut the main refinancing rate to zero from 0.05 percent, reduced the overnight deposit rate, which is paid to banks that keep their money with the ECB, to -0.4 percent from -0.3 percent. It also increased monthly asset purchases by €20 million to €80 billion and enabled investment grade euro-denominated bonds issued by non-bank corporations established in the euro area to be included in the list of assets that are eligible for regular purchases, Reuters reported.

The main target of the ECB’s policy is to boost inflation, which also according to the ECB’s prognosis should be 0.1 percent in 2016 while its inflation target is 2 percent. The 2-percent inflation rate is required, based on economic theories, otherwise a deflationary spiral could be put into motion. It means that people postpone consumption because they are waiting for another drop in prices. This slows down the economy, which reduces inflation even more.

Slovakia has been in deflation for two years, especially due to free trains for students and pensioners and the reduction of VAT on some foods, and a significant shift is not expected. In February consumer prices decreased by 0.4 percent year on year, while the inflation rate was -0.3 percent in 2015.

Some analysts see the ECB’s steps as counterproductive.

“Negative interest rates have exactly the effect opposite to what central bankers assume,” said Markéta Šichtařová, analyst of Next Finance as cited by the TASR newswire. “They will not force people to stop saving and start spending more, but contrary to this they will scare consumers because the mindset of an ordinary person is not to deposit money into bank and to get less one year later due to negative interest rates.”

Martin Vlachynský, analyst of the Institute for Economic and Social Studies (INESS) pointed to a third ECB measure, that is the launch of four programmes of long-term refinancing operations (TLTRO), or simply loans for banks. They will have maturity of four years when they will be offered at the ECB’s main refinancing rate, that is currently zero and may decrease to ECB’s deposit facility that is currently at -0.4 percent. This means that the ECB is preparing to pay, for the first time in history, to banks for borrowing money from it, Vlachynský wrote for the Hospodárske Noviny daily.

Impacts in Slovakia

Reduction of the key interest rate by ECB may bring even lower interest rates on mortgages and consumer loans in Slovakia. Already before the ECB’s decision banks offered mortgages at rates below 1.5 percent and consumer loans below 5 percent.

Analysts expect that banks would keep their rates low for a longer time than they originally planned when rates on mortgages are at historical lows. For example, UniCredit bank offers a rate of 1.19 percent with a three-year fix.

“I assume that banks will stick to low rates and that they will cut them further after a while,” Maroš Ovčarik, a financial expert from www.financnykompas.sk website comparing bank products, told the Sme daily, while not daring to estimate how low they may decrease.

Analysts do not expect rates to decrease below 1 percent. Clients also may benefit from the reduction of the fee a client has to pay for an early settlement of a mortgage as of March 21, which may further encourage people to take a mortgage from one bank to another in order to get lower rates.

“Rates of Slovak commercial banks decreased over the last few weeks in what might be a response to the expected cut in rates from the side of the [European] central bank,” Mária Valachyová of Slovenská Sporiteľňa told Sme.

The bad news is that interest rates will be low on deposit products and ordinary accounts, too. Already, interest rates on ordinary accounts are zero or 0.01 percent while rates on time deposits are hitting 11-year lows and are at about 1.3 percent on average.

Low rates may have a positive influence on companies that can borrow more cheaply and invest more. But this might be not enough as for the development of investments it is also important to what extent the private sector manages to generate new profitable investment projects, Vladimír Vaňo, head of CEE research at Sberbank Europe, told Hospodárske Noviny.

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