Eurozone cheers ECB’s monetary policy
European markets rallied on Friday, March 11, after the ECB (European Central Bank) surprised markets by cutting interest rates further and expanding its bond-buying quantitative easing program in efforts to boost the sluggish European economy (FEZ). The key deposit rate was reduced by 10 basis points to -0.4%, and the monetary stimulus program will be increased to 80 billion euros starting in April. This news sent Europe markets and the euro soaring. The SPDR EURO STOXX 50 ETF (FEZ) rose 3.1% last week, while the iShares MSCI Europe Financials ETF (EUFN) rose 4.3%. Eurozone banks in the so-called “peripheral” nations of Italy, Spain, and Portugal gained on news of the ECB’s plans for a new round of cheap funding for the sector.
On Friday, shares of major Eurozone banks recorded big gains. Deutsche Bank (DB) rose 7% despite its weak earnings guidance. Credit Suisse (CS), a Switzerland-based bank, rose 6%. In comparison, Barclays (BCS), UBS, and Royal Bank of Scotland recorded gains of ~4% in Friday’s trading session.
Is a negative interest rate really beneficial for banks?
Despite last week’s reaction to the news, experts have always questioned whether the ECB’s current monetary policy could cripple the already weak European financial sector. A negative interest rate policy hurts banks. Interest rates are the most important driver for banks as they determine their net interest margins. Banks are in the business of funding their long-term loans through short-term liabilities in the form of deposits. The spread between what they earn from these loans and what they pay out as interest on these deposits is termed as net interest income. As the yield curve steepens, these margins grow, thus improving profitability.
Similarly, if central banks adopt a negative interest rate policy, banks stand to lose billions of dollars of revenues on their deposits with the central bank. Further, their profit margins are hurt when a negative interest rate is implemented.