9 June 2016

The risks of low and negative interest rates in the Eurozone

By Pieter Cleppe & Cindy Morand

From around 4% in 2008, the ECB has been lowering its benchmark interest rate to a record low 0.0% today. In June 2014, it cut the interest rate on its deposit facility to -10 basis points (bps), a big change from 2008 when the rate was 325 bps. Most recently, the central bank cut its deposit rate further into negative territory to a fresh new low of -40 basis points with effect from March 16, 2016.

It should be stressed that this short term rate setting by the ECB is only one of the factors leading to long term rates going steadily lower in recent years, apart from increased international saving and the expansionist monetary policies of other leading central banks. A contrarian could perhaps even describe low rates as a sign of economic health, pointing out how in the fifteenth century in Europe, interest rates fell from 14 per cent to 5 per cent. They even hit 3 per cent in the Netherlands in the sixteenth century, then at the lowest level in Europe. The jury is still out to what extent today’s low rate environment is “artificial”, as a result of central bank activism, or “natural”, as a result of increased saving due to increased wealth.

In any case, ECB President Mario Draghi has always defended this “accommodative” monetary policy” as a means to “support prospects of an economic recovery”, as he said back in 2013. Whether this target has been reached is a matter for debate, which isn’t so easy to settle, given that we can’t be sure what would have happened otherwise. What is certain, however, is that low interest rates do have material consequences. Hereunder we’ll provide an overview of these:

  • A debate erupts about possible losses for savers, insurance firms and pension funds

Especially in the North of the Eurozone, there has been a lot of discontent over the relentless decrease in return savers enjoy from their deposit accounts. Several German institutes have come up with estimates of the cost. According to DZ Bank, after six years of low rates, the average German citizen will have lost out on €2,450 by the end of 2016. Germany’s prominent IFO institute also took into account the damage low interest rates have wrecked upon life insurances and private pensions, claiming that combined with the losses for deposit accounts, the cost for Germany alone amounts to €327bn euro since 2008.

These calculations may overlook that one can’t assume that interest rates would have stayed at a higher level, given the disruption of the financial crisis in 2008. Some would even contend that one can’t assume the mere survival of many banks in the absence of extraordinary central bank measures, which include lowering short term interest rates.

In the Netherlands, where pension funds manage more than 1 trillion euros, they were forced to cut payouts and may need to do so again. This led to the pension industry sounding the alarm, calling the situation “dramatic”. The Dutch Central Bank President was even convoked to Parliament for an explanation. Those trying to counter the criticism have argued that the payout cuts were due to the Dutch regulations requiring pension funds to have a cushion. Disagreements persist whether these regulations are too stringent and even if so, whether they should be relaxed to alleviate the effects of lower interest rates.

Also Germany’s very large insurance industry, which was forced to reduce benefits for clients, has complained. This, along with the criticism from German savings banks, contributed to sharp political attacks from senior German policy makers. Bavaria’s Finance Minister Markus Soeder dubbed the ECB’s interest rate policies “gradual expropriation” of savers and insurers. German Finance Minister Schäuble and deputy Chancellor Sigmar Gabriel, a social democrat, have also blamed the ECB.

Mario Draghi has responded by saying that the ECB isn’t really responsible for low rates, claiming these really are a consequence of a “global excess of savings” and are “a symptom of low growth and low inflation”.

This indeed goes to the heart of the debate: to what extent is the ECB, which can only set short term rates, also responsible for long term rates? It must be said the ECB sends out contradicting signals here, as it boasted in one of its recent publications that its “credit easing” had “significantly lowered yields in a broad set of financial market segments”. Low and negative rates are also seen as part of the ECB’s perceived overall dovish monetary policy, along with QE, which helped to expand the ECB’s balance sheet, making it even less credible for the ECB to claim it can’t really be blamed for any of it all.

Even if one would be able to prove the ECB and other central banks have been key in driving interest rates down, one could argue – as they would – that these so-called “stabilisation benefits” may have helped avert more damage to savers, pension funds and insurers. To which the opponents then would retort that a long overdue correction, which would also avoid moral hazard, may have been beneficial for the health of the system on the long term.

However, one important element in this discussion is that since 2011, the real interest rate on German savings, distinct from the nominal interest rate, has actually been rising. This is due to falling consumer prices, which partially are the result of international factors, such as China’s deleveraging. So when ordinary savers see their interest income disappearing, they should actually be happy to have more purchasing power thanks to statistics showing falling prices. In theory, these stats also take into account Germany’s increasing real estate prices.

Obviously, one could argue that their purchasing power would have increased even more in the absence of low nominal interest rates. Then again the deflationary pressure may have also hit their salaries, at least in the short term, but from an Austrian economics viewpoint, it’s a necessary – and painful – adjustment needed to kick-start growth again. This all indicates that in a globalized economy, debates about purchasing power and inflation aren’t easy to settle.

  • In the Eurozone, people save less for a rainy day

Another effect of the ECB’s low rates seems to be that people save less for a rainy day. That’s true at least for people in the Eurozone, as the global savings rate is up since 2009. Eurozone households saved 7.77% of disposable income in 2008, which is now down to 5.71%. Net saving per inhabitant in the Eurozone has even decreased by a whopping 50% during the last few years, from €2,400 at the end of 2007 to only €1,200 in 2013.

Obviously, correlation may not be causation and other factors, such as higher unemployment, also play a role here, while a detailed country-by-country look reveals sharp differences. A big drop in the percentage of households saving their disposable incomes can be witnessed in Austria, Belgium, Italy, Greece, Slovenia and Ireland, while not much has changed in Germany, France and Finland. In Estonia, the Netherlands and Slovakia.

In any case, an economic crisis affects this: it can drive the savings rate even lower, or sometimes even up: the Dutch real estate market went through a severe crisis, as up to one in three house owners were in negative equity, and still the savings rate increased. In Greece, which suffered its well-documented crisis, a modestly negative savings rate of -3.84% in 2008, then broadly similar to the one in the Netherlands, turned into a massively negative 17.28% in 2014.

Household Savings – Total, % of Household Disposable Income


Source: OECD (2016), Household savings forecast (indicator)

Government finances in the Eurozone may be affected by the savings rate in the long term. Higher levels of household savings are considered to allow a larger portion of a country’s overall debt to be financed internally, which is seen as more sustainable and explains why for example Japan has been able to rock up its debt to a whopping 229% of GDP.

More fundamentally, long-term economic growth requires capital investment into infrastructure, education and technology, as well as in factories, business expansion. A typical domestic source for this is household savings.

  • Struggling governments and shaky banks benefit

It’s quite well-documented that shaky governments and banks in the Eurozone are kept afloat due to the extraordinary low or even negative interest rates. When the ECB started its “LTRO –programme” in 2011, thereby issuing loans with cheap interest rates to banks, French President Sarkozy openly boasted the real purpose was to fund governments, when he said: “This means that each state can turn to its banks, which will have liquidity at their disposal.”

It should be noted that LTRO may have supported the eurozone’s periphery even more than the general low interest rate policy. This is because a large portion of the financing provided to eurozone banks through the LTRO was used to buy periphery sovereign debt, with eurozone periphery banks in Ireland, Italy, Spain and Greece taking the majority of the first 36-month issue in late 2011.

Long term long interest rates, which, as opposed to LTRO, may only be to a certain extent the consequence of the ECB or other leading central banks, did help governments in an indirect way. They propped up shaky banks and their “bad debt”, so governments wouldn’t have to bail them out. It was estimated by Spain’s IE Business School that in 2011, more than 90% of mortgages in Spain were tied to short-term interest rates and an 0.75 percentage point rate increase would have added almost €1,000, or around $1,430, per year to the average Spaniard’s mortgage payment. Modest ECB interest rate hikes in 2011 may have been one of the triggers pushing the Spanish government to request a €100bn bailout for its banks in 2012 after all. Whether this was the reason or not: the ECB hasn’t dared to increase rates ever since.

As Bundesbank chief Jens Weidmann pointed out, the positive consequences that low interest can constitute for banks mainly exist on the short term, when he explained: “In the short term, banks tend to profit from lower rates, as liabilities have shorter maturities than their assets, meaning refinancing costs will fall before interest rates do (…) But the longer the period of low interest rates continues, the more this eats into interest rate earnings.”

The more recent phenomenon of negative interest rates is somehow puzzling. Why would financial institutions be happy to pay for the privilege of lending to highly indebted governments? One factor explained this are the Basel accounting rules, which declare sovereign debt “risk-free”, something which the “European Systemic Risk Board”, chaired by Mario Draghi, wants to be changed.

  • Certain owners of certain assets classes profit from low rates, amid claims there are investment bubbles

Whether “ordinary” businesses and citizens profit from cheaper borrowing, which may compensate for the damage to savings, isn’t very clear. And even if they would, and for example enjoy higher house prices, some  have claimed a bubble may be around the corner.

As inflation has fallen faster than the ECB has cut nominal rates, overall real interest rates have actually risen substantially in the Eurozone over the past four years. Still, in specific segments, borrowing costs seem to be down:

The cost of eurozone corporate borrowing has steadily fallen over recent years, as a growing pool of corporate bonds emerges with negative yields. This isn’t only due to low rates but also due to ECB bond buying, which drove down yields on sovereign debt, on its turn pushing many investors into the corporate bond market. The eurozone’s periphery certainly also enjoys cheaper borrowing rates. For “non-financial counterparties”, loans of up to 1 million euro with a maturity of 1 to 5 years have even become cheaper in Spain than in Germany.

Mortgage borrowing rates differ a lot across the Eurozone. Despite the fact that both in Ireland and Spain, banks are still coping with the aftermath of epic real estate bubbles, partially caused by membership of the common currency and its easy money, mortgage loans are nowhere more expensive than in Ireland and they are among the cheapest in Spain. On the sidelines, there have been incidents of negative mortgage rates for consumer borrowing in Denmark, Belgium and the Netherlands.

Will this create a new real estate bubble? At least for Spain, a high correlation can be witnessed between lower interest rates and the increase in the level of credit destined to the housing sector.  Also in Germany, however, prominent economist Hans-Werner Sinn has claimed there is a “real estate bubble”, arguing that average urban property prices having risen by more than one-third since 2010 – and by nearly half in large cities. Others have countered that the German real estate market was facing a long overdue upward correction anyway.

Increasingly low rates don’t favour investors into real estate in an equal manner. They particularly help homeowners who already own a house and have negotiated a floating interest rate. They work to the disadvantage of first time buyers or renters, who see prices rise.

Low interest rates also seem to correlate with an increase in the value of European stocks, at least until the middle of last year, when a world-wide correction started. In certain Southern European countries, as for example Italy, this happened despite very low growth and persisting high unemployment, indicating the “bubble zone” may have been reached, but no hard proof of this is possible.

Even if increasing stock or house prices may benefit a number of citizens, they don’t so in a consistent way. Only a small fraction of households in the eurozone – between 5% and 12% – own bonds, publicly traded shares or mutual funds, according to the ECB.

It won’t come as a surprise that it’s mainly the rich who invest in stocks: according to the ECB, among households in the lowest quintile of the income distribution, only 2.2% own publicly traded shares, in contrast to 24.4% in the top quintile. Certainly ECB President Mario Draghi wouldn’t be surprised, given how he admitted last year that the ECB’s aggressive monetary easing may contribute to inequality, mentioning how “the distribution of wealth” may be affected.

That manipulating interest rates carries along the risk of creating investment bubbles, is the main reason why savers should be wary to take Mr. Draghi’s advice that they “shouldn’t just invest their money in savings accounts, given that there are other possibilities”. Perhaps precisely because of the fact that Draghi’s “other possibilities” carry more risk, it’s mainly those with more resources who have been exploiting them.


The debate on the effects of low long term interest rates is fraught with controversy about whether and to what extent central banks even have the power to affect long term interest rates, whether they should try to manipulate them and what the consequences are. The overview above makes clear that the effects are in any case material and that the ECB has some role in all of it, but it’s hard to determine how big that role has been.

Pieter Cleppe and Cindy Amelie Morand are with independent think tank Open Europe