ECB PUSHES DEPOSIT RATE FURTHER INTO NEGATIVE TERRITORY: THE IMPLICATIONS FOR REAL ESTATE
CBRE's Head of EMEA Research Neil Blake examines the latest announcement from the ECB and its impact on property.
The ECB announcement
On 10th March Mario Draghi, Governor of the ECB, announced a new set of monetary stimulation measures, namely:
1.The main re-financing rate was reduced to 0% (from 0.05%) and the rate on the marginal lending facility was cut to 0.25% (from 0.3%).
2.The interest rates on banks’ deposits was reduced 10bps to -0.4%.
3.Monthly bond purchases under the asset purchase programme (quantitative easing) will be expanded by €20billion to €80 billion per month and the programme is extended to the end of Q1 2017; high grade corporate bonds are also eligible for purchase for the same time.
4.There will be a new Targeted Long-Term Refinancing Operation with a -0.4% interest rate when conditions are met.
The cut in the main re-financing rate and the marginal lending rate makes it cheaper for Euro-area banks to borrow short-term from the ECB. The deposit rate was already negative - meaning banks have to pay even more (10bps) to make short-term deposits at the ECB.
Why has the ECB announced additional policy measures?
The ECB has had to downgrade its inflation forecast to close to zero by the year end which is some way off its “close to 2%” target. Much of this is due to weaker energy price expectations but the “core” inflation forecast has also been reduced to 1.1% (from 1.3%). The ECB will also have had its eye on the financial volatility that has been a feature of the year so far.
Growth in Euro-areas’ economies picked up in 2015 and unemployment fell (the unemployment rate is now 10.3% down from over 12% in 2013). Economic confidence also remains quite positive but the fear is that low headline inflation, caused by low energy prices, will feed through to low wage inflation and lower “core” inflation.
Deflation (falling prices) can be damaging for the economy in a number of ways. In particular, it makes it harder for governments to keep public finances under control, especially where public sector debt is high (predominantly in southern Europe) as it tends to mean that tax receipts fall relative to the debt. Low inflation also causes problems but to a lesser degree.
QE and negative interest rates affect the economy in a number of ways. The exchange rate tends to fall which promotes economic growth by encouraging exports and discouraging imports (pushing up the price of imports also has a direct impact on prices). The idea is also that lower interest rates make the cost of borrowing cheaper which encourages companies to invest and consumers to spend. To some extent, the ECB’s QE programme that was instigated around this time last year has succeeded in these aims.
Are negative interest rates beneficial?
Negative deposit rates are intended to encourage banks to lend by making it more costly to hold money on deposit at the ECB. The zero re-financing rate and low marginal borrowing rates will make borrowing cheaper. This should be beneficial for borrowers but it can cause complications for banks. Banks cannot pass on negative interest rates to their depositors as customers would be deterred by paying to keep money in a bank - there are back door ways of getting around this such as charging for accounts but this would not alleviate the problem altogether. Low interest rates on lending and negative interest rates on their deposits squeeze banks’ margins. Following the instruction of negative interest rates in a number of other countries, notably Japan, many argued that this is counter-productive, particularly at a time when banks are struggling to restore profits in order to hit targets for capital adequacy ratios.
The ECB’s latest policy announcement, however, looks like a clever way around the problem. True banks will be penalised by leaving money on deposit, but the new Targeted Long-Term Refinancing Operations (TLTRO) act as a counter balance. Banks taking advantage of TLTROs and who hit the ECB’s lending targets (that’s the “targeted” part of the LTRO) will be paid, through negative interest rates, by the ECB to borrow money and will then lend it on to borrowers at a positive, if low, rate of interest. This is a subsidy that will help to build the margins of the banks that take advantage of it. This is effectively an attempt to shift money from banks who do not engage in additional lending (but who suffer from negative interest rates on their deposits at the ECB) to those who do (who benefit from negative interest rates on loans from the ECB).
What does it mean for property?
If the policy succeeds in encouraging bank lending and bolstering economic growth in the Euro-area then property will benefit along with the rest of the economy but there are also a number of property-specific effects to watch out for. Chief of these is the impact on long-term interest rates. Short-term interest rates (ECB policy rates) are unlikely to go up by much while QE is in operation which has now been pushed to March 2017 at the earliest. Further, ECB Governor Mario Draghi said, in the press conference that accompanied the latest policy announcements, that he expects interest rates to remain very low well beyond then.
Lower policy rates and more QE will act to push long-term government bond yields down further or at least to keep them lower for longer. Lower long-term interest rates benefit all real estate (although banks’ appetite for lending to property is limited by ‘regulatory risk weighting’ not just banks’ financing costs) but the benefit is far bigger for prime property. Today’s interest rates makes the return for investors looking for safe, long-term income producing, investment very low and it seems this situation is not going to change any time soon. This pushes investors towards “near-bond” type investments such as prime property, particularly prime property that comes with secure long-term income. All of this means that there will be further scope for yield compression in prime Euro-area property markets - despite their present low level - and they may stick at low levels for some time. There is also likely to be a knock–on effect to other European property markets, particularly in Central Europe where current prime yields will look increasingly attractive compared to what is on offer in the Euro-area. London may be an exception given that it is already expensive and given the Brexit uncertainty. That said, if UK long-term interest rates stay low throughout the year and into next we may still see further downwards pressure in yields if there is a “stay in” vote in the referendum.
More QE and lower interest rates in the Euro-area also points to the continuation of a weak euro for some time. The relationship between exchange rates and property investment is complex but there has been anecdotal evidence over the past year that US investors are attracted to investments in the Euro-area. They believe that the euro will eventually rebound against the US dollar and give them an exchange rate gain as well as the usual investment return on property investment.
Last, and possibly not least, monetary easing by the ECB will be another factor (in addition to the recent financial market volatility) that might make the Fed follow a more dove-ish path with US interest rates in 2016 because of worries that the dollar would strengthen further and damage the US economy. This has implications for property well beyond the borders of Europe.
 Inflation excluding energy, food and alcoholic drink
 See the CBRE ViewPoint: “Real Estate in a World of Negative Interest rates”, forthcoming.