Europeans Growing Weary of Low Interest Rates

Europe

In a world where economies are so connected, we can no longer to afford to not pay attention to what is happening anywhere, and especially in an area as large as the EU.

From taking a cursory view of the changes in the economic situation in the U.S. and elsewhere, the economy of the United States is thought to be heading toward leaner times, and Europe is especially seen this way.

Thinking such things would definitely serve to dampen our enthusiasm about not only the economy but of our view of financial markets as well, especially stock markets, which are known to struggle and sell off quite a bit in fact in the face of genuine economic turmoil.

We saw this in full force during the subprime mortgage crisis and the banking crisis that ensued, which saw stocks simply get hammered. When we see people out there worried about the economy again though, we do need to seek to understand what is actually going on to be able to measure any potential threats and also have a sense of how likely we are to need to worry.

For many, the worrying is already well underway, even though the troops on our side have already been deployed so to speak with the end of quantitative tightening which slows the economy and the resumption of interest rate cuts, or a cut at the very least.

We then may look to Europe where their central bank interest rate is already below zero and they just put it down another tenth of a percentage to have them now sitting at minus 0.5%. This may even strike us as acts of desperation and perhaps we are getting a glimpse of where the U.S. may be headed a little down the road, where all the king’s cuts don’t seem to cut it.

A lot of people in Europe are becoming quite upset at this ultra-low interest rate environment, although these people do mostly focus exclusively on their nominal rate of return and not the return net of inflation, but in this case neither metric would put anything but a frown on the face of savers.

When the economy runs too hot, central banks basically come to the rescue of savers to not let their savings devalue too quickly. This is what savers need to worry about the most, as the spread widens when inflation runs too high, meaning that their net losses tend to be bigger in high inflation and high rate environments than in low inflation and low rate ones.

You can still get a third to a half of a point on your money in Europe if you shop around, so it’s not that people get negative rates when they save, although they are historically very low. So is inflation though.

The ECB Has Fought this Battle Very Well

When we need to ramp up our economies though, rates do need to be lowered, although lowering interest rates isn’t the only tool that central banks have to affect the economy, as they also rely on what we call quantitative easing, where the central bank creates money and purchases assets.

This is, of course, inflationary, and when they sell assets this is in turn deflationary and will cool economic growth, and in the situation, we are in now, we want to stimulate the economy and inflation in turn.

We might wonder why we just don’t rely on quantitative easing and leave interest rates alone, and perhaps make the savers happy as well, but this needs to be a concerted effort to work, where you do both and they work synergistically.

The ECB is not only still lowering interest rates, they are also ramping up the amount of asset purchasing that they have been doing, where they will now be buying up to $20 billion euros a month. The two moves really go together, and central banks will carefully examine how to best deploy both tactics to best achieve the desired effects.

With the ECB throwing more and more ammunition at the problem of economic slowdown in Europe, we need to next ask how they are making out with this, and especially whether it is effective or not at this point.

There is a view out there that the power of central banks has diminished now given that interest rates are already so low, and with them being in the negative in Europe, that would certainly qualify as low. People are assuming the same thing about the Federal Reserve as well, even though things haven’t gone anywhere near as far as they have in Europe, and they have a lot more ammo left.

The Fed also has a lot more means to use quantitative easing, which we saw during the subprime crisis where they threw $4.5 trillion at this, most of which is still on their balance sheet all these years later. They did start to shrink this but that has now been postponed, but it’s not as if they are out of money, as the Fed simply creates more when it needs to.

It is hard to imagine why anyone would think that the Fed in particular would have considerably limited power in this environment, and putting rates back to zero and resuming quantitative easing would be well in excess of what would be needed to bring the economy back to full health and then some. What would happen is the Fed would have to pull back, like they did a few years ago when things started growing too fast and rates were hiked in response.

This is why the Fed is so careful with changes that they make, instead of just giving in to Trump and setting the rate back to zero straight away. We would see too much growth, even more than what we saw in the first half of 2019, which was promptly halted. The ideal here is one of smoothing, and overreacting and requiring remedial action is to be avoided.

Europe Actually Looks Pretty Good in the Areas that Matter

In Europe though, they do have the pedal to the metal and are looking to find more horsepower. The numbers in Europe aren’t really that bad though and certainly well within the comfort zone, should we understand what the comfort zone is.

We need to realize that there’s nothing more important than employment data when it comes to looking to avoid a recession. Unemployment is the pointy end of this stick in fact and is what happens when the economy turns bad. Unemployment and the economy turning bad could even be held to be the same thing.

Europe’s unemployment rate is nowhere near as low as in the U.S., but it has come down from 11% in 2013 and since trended downward to today’s 6.3%, which is a record low.

Economic growth and inflation are in a comfortable range and on a steady course and are expected to remain so in the foreseeable future. With the ECB still pushing, this provides us with even less reason to worry. Europe’s economy may not be as strong as the United States is right now, but it’s actually pretty close, and is as close as it is due to the efforts of the ECB to seek to stay ahead of this.

There is a worry out there about how Europe’s ultra-low interest rates are affecting their banks, and banks certainly do not love rates this low. While these concerns are valid, European banks have shown some improvement lately in terms of stress tests, and this is more about their having to settle for smaller profits than their being placed in peril.

Whenever we enact policies, we are forced to choose between competing interests, and choose the one that is the most compelling. This will not make everyone happy, and ultra-low interest rates won’t make savers or those who own bank stock very happy, but the greater good takes precedence and is what is being sought.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.

Contact Ken: ken@marketreview.com

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