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Europe's €1 trillion stimulus means investors pay to borrow

Published:Wednesday | March 11, 2015 | 12:00 AM
The European Central Bank, Frankfurt, Germany.

Lend a friend a thousand bucks. Then tip him US$10 for the privilege.

That's not how things work in everyday life. But that's the deal in many European government bond markets these days.

Yields on some government bonds have become negative - one of the many important, and sometimes odd, effects of the €1.1-trillion (US$1.2-trillion) stimulus programme that the European Central Bank (ECB) launched Monday.

The chief monetary authority for the 19 countries that use the euro says it will buy €60 billion in government and corporate bonds through at least September 2016, to get inflation higher and help growth. The ECB makes the purchases by creating new money, a privilege it has as the legal issuer of the euro.

The stimulus' main goal is to boost inflation, which is low at minus 0.3 per cent. The ECB faced fears that the Eurozone could fall into a deflationary spiral of falling prices, wages and growth.

The written account from the January 22 meeting, where the stimulus was decided, shows the 25 members of the ECB's governing council were concerned about such a scenario.

Members felt that the Eurozone wasn't yet suffering from deflation, and that the risk was hard to estimate. But the decision was that the risk of not acting was worse than the risks of inaction. Japan fell into deflation in the 1990s and is still trying to get out.

The programme's main effect should be to make market interest rates fall.

The purchases ought to drive up bond prices, pushing down their yields. In fact, bond prices had been falling well before Monday, partly in anticipation of the stimulus. German two-year bonds yielded minus 0.22 per cent on Monday, and other countries' yields have also dropped significantly.

That saves governments such as Italy and Spain much-needed money as they try to lower their debts. They have to spend less on interest, easing pressure to do growth-killing spending cutbacks.

So who would buy a bond with a negative yield? Some investors, such as insurance companies or pension funds, may need to purchase only highly rated assets - and most of those yield very little.

Other investors may simply be willing to pay for the safety of getting their money back.

And some may be thinking that deflation really will set in, and that the negative yield will still outpace the negative inflation rate.




The stimulus' effect of lowering market rates is hurting one part of the economy - savers.

The low rates are meant to encourage people and businesses to spend and invest, in the hope that will increase business activity and economic growth.

Very low or negative rates, however, make it harder for people saving for retirement to find safe investments that beat inflation.

They also squeeze earnings for banks and insurance companies by reducing the difference between the rate they pay and the rates at which they lend.

One of the biggest effects of low and negative rates is to weigh down the euro, especially against the dollar. US rates are heading north due to speculation that the Federal Reserve will lift rates this year. All things equal, higher rates tend to strengthen a currency.

The euro has slid from US$1.40 in May to US$1.09 on Friday and many expect it to fall further.

One beneficiary will be US tourists headed for the Eurozone this summer. The fall in the euro since last spring lowers the €16 price of an all-exhibits ticket to the Louvre museum in Paris from US$22.40 to US$17.45. A budget-level hotel room within sight of the Eiffel Tower costs €163 for an April booking, or US$178. That would have been US$228 at last spring's exchange rate.

In Europe, exporters are enjoying the euro's drop as it makes their goods more price-competitive in the international marketplace.

One goal of Europe's stimulus programme is to get growth and job creation going again, as well as restoring inflation to normal levels.

That seemed to be happening slowly before the stimulus was launched. The Eurozone jobless rate has fallen to 11.2 per cent from 12 per cent at its peak in 2013.

But the ECB has given no clear guidance on what jobless rate it wants to see before it considers the job done. The US Federal Reserve, by comparison, said it targeted a jobless rate of 6.5 per cent or lower when it conducted a similar stimulus effort.