Europe Closes the Crazy Parenthesis of Negative Rates.

Could the housing bubble burst?

It's more than a symbol. The Swiss National Bank (SNB) raised its main policy rate by 75 basis points on Thursday 22 September 2022, to 0.50%. Before this move, it was the last of the European central banks to practice a negative interest rate policy (NIRP). It was also the first to do so - implicitly - between 1972 and 1978. It did it again, openly this time, in 2014.

The European Central Bank (ECB) in July 2022 and the Bank of Denmark two weeks ago also raised their rates above the 0% threshold. Only the Bank of Japan is still resisting, with a money rate of -0.1%.

RIP NIRP. This is indeed the end of a revolutionary era for monetary policy: it was the banks, which lent to the central bank, that paid the interest. The Swedish Riksbank opened the ball in 2009, followed five years later by its Danish counterpart, the ECB, and the Swiss monetary institute.

An experiment meant to be an electroshock

Throughout Europe, this “experiment” was conceived as electroshock, brutal and short. The objective, at the time, was to revive moribund inflation and support the economy. The Swiss central bank was also struggling with an overly strong franc, and hoped to reduce the appetite for its currency. It eventually lasted more than ten years, even becoming a standard tool in the monetary policy landscape. And its effects were felt throughout the financial world.

Governments, but also highly rated companies, and even individuals in some countries, made money by taking on debt. The virtuous chain that central bankers hoped for was the following: with negative interest rates, business investment and household spending would pick up, and price increases would come closer to the target they had set.

Anger of savers in Northern Europe

It has not been a success. On the Old Continent, it was the reopening of the post-COVID economy, combined with the impact of Russia's invasion of Ukraine on energy prices, that caused inflation to soar. Negative interest rates, however, have allowed governments to help citizens and businesses through the pandemic, with the cost of debt allowing for massive borrowing on the markets.

On the banks' side, however, the potion has been bitter. The negative rate applied to their excess reserves has cut into their profitability. The ECB did put in place a tiering system, which exempted part of their deposits from this de facto taxation. This gave them some breathing space.

But, according to the calculations of Eric Dor, director of economic studies at IESEG, the bill for banks still amounted to 1.5 billion euros per month before the increase in June 2022. This rent for money under 0% has also provoked massive anger among savers, mainly in Northern Europe. First of all, they were faced with a lack of return on their investments. But in addition, their banks had decided to “re-invoice” them for part of the de facto taxation that they were suffering on their deposits with the central bank.

Some people preferred to transform their bank deposits into cash and rent a safe to store their bills, rather than pay interest to their bank.

Could the housing bubble burst?

In financial markets “addicted” to negative interest rates, the search for yield has pushed investors into increasingly risky assets, which could prove dangerous if the economy falls into recession. The real estate sector is also under serious threat. The low cost of credit has artificially inflated property valuations.

According to a study published in May 2022 by the ECB, housing prices in Europe are overvalued by 15%, and even by 60% in some countries. Could the bubble burst? Not as long as mortgage rates are below inflation, the central bank has tempered. But the rapid rise in key interest rates is likely to shake up the market.

Ironically, the European central banks are in turn suffering the side effects of this sub-zero rate policy. A large part of the government bonds they have bought over the last two years has negative yields. They are therefore left with a portfolio that yields little. At the same time, the ECB's key interest rate increases mean that they must now effectively pay interest on bank deposits. This is a catch-22 situation that puts their profitability at risk. One after the other, the National Bank of Belgium and the Netherlands Bank have warned that they will end 2022 in the red.

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