Late last week, the European Central Bank (ECB) announced a raft of policy actions designed primarily to address the supposed threat of deflation. Paraphrasing Jim Grant, they’re planning on saving Europeans from everyday lower prices.
The policy changes included a reduction in the refinancing rate from microscopic to sub-atomic (now 0.15% p.a.). More controversially, the ECB deposit rate drops from zero to minus 0.1%—negative interest rates. If a commercial bank deposits cash with the ECB overnight, it now pays rather than receives interest (making it much like my transaction account, really). This is intended encouragement for banks to lend more freely.
It’s also stopped the practice of sterilisation, meaning money supply will rise. Europe is preparing to join the US, UK and Japan in the practice of quantitative easing. If any of this is lost on you, Fairfax published a fairly decent plain-English explanation of the changes, Just what are negative interest rates?
The ECB is hoping to encourage economic activity and also avoid deflation, that great central banker bugbear that hasn't been particularly apparent in my weekly grocery bill. They also (probably) want to push down the euro exchange rate against other major currencies, giving European exports and import-replacement companies a boost.
Will negative interest rates and sterilisation make banks want to lend to businesses, simultaneously making businesses want to borrow more to invest in new ventures, creating jobs and inflation in the process? That’s an argument I’d rather leave to wise seers, and Paul Krugman. But I will point out that European corporate bond markets are well and truly open to most corporations already today, with very cheap financing available and new offerings massively oversubscribed on a regular basis. Is the intention to make sure that European companies are not only well-sated, but thoroughly stuffed?
Rather than set off some gold rush of factory and payroll expansion and directly nudge up the price of Weißwurst, camembert and espresso, that money is more likely to find its way into asset prices. It’s what’s happened with most central bank expansionary policies over the past few decades, and it’s what’s been happening in Europe already.
I’ll use my current home city as an example. Vienna is known as a beautiful city with, for the most part, affordable property prices. According to the Austrian National Bank, like-for-like apartment prices rose just 10% in the decade prior to the financial crisis’s onset in 2007. That’s in nominal prices, not inflation-adjusted.
There are good reasons why property prices here should be lucky to keep up with broader inflation. Vienna’s population today is lower than it was in 1900, though it covers a greater landmass and has many more buildings than it did 114 years ago. It’s a similar story at the national level. In the 55 years it’s taken Australia to go from 10m to 23m residents, Austria has gone from 7.1m to 8.5m. The fertility rate is way below replacement levels, and net immigration barely brings it up to population maintenance levels.
A property boom just doesn’t seem justified by fundamentals. And yet that is what is underway. In the six years to the end of 2013, Viennese property prices have risen 65%, about 9% per annum. Today, they're a long way from cheap. While we’ve all been reading about Europe’s economic Armageddon, the Viennese have been saving up, borrowing from those supposedly tightwad banks and bidding up property. Rents have risen but to nowhere near the same extent. It’s a similar story in many cities in the richer parts of Europe.
Anyone who says recent ECB policy is not inflating prices is clearly not looking at my local property rag. Last week’s announcement merely pushes that impetus a little further, and the full effect will be felt in European property and stockmarkets before long.
Central bankers tend not to mind some asset price inflation in order to encourage a knock on effect to the real economy. Maybe that’s justifiable, sensible even in some contexts. But they're acutely prone to getting addicted to the cheap juice. If the global financial crisis taught the world anything, it’s that the bust part of the boom-bust cycle can be a really horrible and damaging experience. It's better avoided. The ECB and other central bankers ignore that lesson at their, and our, peril.
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