What ECB’s Tiering Means
for Gold
In a key policy shift, the ECB has recently
introduced tiered system of interest rates. This news isn’t of interest only to
the banks keeping their reserves at the ECB. In today’s article, you’ll learn
about the new instrument of monetary policy, and find out what it implies for
the gold market.
If you think that monetary policy in the United
States is crazy, you are right. But in Europe, it is even stranger (and in
Japan, it is really insane). As you probably remember, in September, the ECB
introduced a package of measures to ease monetary policy further in the face of
sluggish economic growth and subdued inflation. In particular, the Governing Council resumed quantitative easing (the bank will be purchasing €20 billion of assets
monthly), eased the
conditions for TLTRO operations, strengthened the forward guidance strategy,
and – the crème de
la crème – cut the deposit rate by 10 basis points from -0.40 to -0.50
percent, as the chart below shows. The ECB used, of course, all these
instruments already in the past. What is
really new is the introduction of the tiering system. How does it work and
what could be its consequences for the euro area economy and gold prices?
Chart 1: ECB’s deposit rate from January 1999 to
October 2019.
In the ECB’s tiered system of interest rates, a
portion of bank deposits, currently set at six times their mandatory reserves,
is exempted from the negative deposit rate. In other words, reserves below a threshold bear zero interest, and only excess of reserves above this
threshold is subject to negative interest. The idea is to limit the harmful
effects of negative interest rates on banks’ profitability. This is why most of
the central banks that implemented NIRP have some form of tiering system. For
example, due to tiering, the percentage of reserves subject to negative
interest rates in Japan is only about 5 percent.
You
might ask now why, the heck, introduce negative interest rates in the first place and then implement neutralizing
measures? That’s a great question, but not for us, but for a psychiatrist. But our guess is that the ECB used the NIRP to weaken the euro, as it is the only channel through which its
monetary policy somehow still works,
but the banks were fed up watching their bottom lines turn red, so the ECB
tiered the interest rates. Now, everyone is happy.
Really?
Not so fast! The tiered system is welcome, but its introduction came too late for a sector hurt by years of ultra-low
interest rates. And the relief will be too small, as it would result in
annual saving of only about €2-3
billion euros for the entire euro zone banking system, around one third of the
total costs of the NIRP that banks would have to bear without the tiered
system.
Moreover, investors should remember that the euro
area banking sector is heterogeneous, so not
all banks will gain to the same extent. As German and French banks have the
most reserves, they suffered from the NIRP the most and they will feel now the
greatest relief. It means that the policy won’t make its hit to the maximum and
that there might be some side effects.
But what is perhaps the most important is that the implementation of tiering system
tightened the monetary conditions. The ECB cut deposit rates, but the money
market rates rose. Why? Quite simply. Tiering means that many reserves are
exempted now from negative interest rates. They are subject to the zero
interest rate, and only a part of them bear interest rate at -0.50 percent.
Hence, the banks’ weighted deposit rate at the ECB increased from around -0.37
to -0.25 percent. It’s not clear how the tightened monetary conditions are
supposed to stimulate economic growth in the euro area. Higher interest rates should support the euro and also the yellow metal
on the margin.
However, although the introduction of tiering
provides some relief for commercial banks’ profitability and increases the
inter-bank interest rates, it extends
the possible time of the NIRP in the euro area and expands the room for even
more negative interest rates in the future. As banks are now partially
shielded from the disastrous effects of the NIRP, the ECB could hesitate less before the next reduction of its
policy rate or delay the normalization of its monetary policy.
The sluggish growth combined with lower yields should weaken the euro and gold prices
against the U.S. dollar in the medium term.
However, given the ultra-dovish stance of the ECB and unwelcome upward pressure
on the greenback, the Fed might be more inclined to follow suit and also adopt
a more accommodative stance. It could cut the federal funds rate as early as in October. Thus, if the ECB’s tiering
translates ultimately into a more dovish Fed, it should affect gold prices positively.
If you enjoyed the above analysis and would you
like to know more about the fundamentals of the gold market, we invite you to
read the November Gold Market Overview and Fundamental Gold Report. If
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Thank you.
Arkadiusz Sieron
Sunshine Profits‘ Gold News and Gold Market Overview Editor
