Europe to Continue Punishing Savers

Back in 2014, the European Central Bank (ECB) lowered interest rates close to zero.

Real interest rates in savings accounts were negative. That is, if you kept money in the bank, you were losing money.

You see, negative rates work as a kind of tax on people holding money in the bank. Instead of the bank rewarding you with interest for using your money, you lose money.

With this unconventional move, the ECB was looking to encourage people to spend and borrow more…and to save less. They were hoping low interest rates would boost the economy and spark inflation

As you can see, European central rates have been flatlining for a while now.


Source: Trading Economics
[Click to enlarge]

But the plan backfired.

Instead, the savings rate increased during this period. Germans started saving more, even if it meant they were losing money.

Why?

Well, we are not really sure.

It could be because Germany has an ageing population. An older population tends to save more as they approach retirement.

Or it could be that when you lower interest rates to zero, people are less confident about the future. People will usually spend money when there is a positive outlook in the economy.  Zero interest rates don’t project a great outlook on future growth, which could be why people decided to save more.

Or it could be that people thought the ECB’s negative interest rates were outrageous. Something that would only happen in an upside-down world. A system that punishes savers and rewards borrowers…so they did the opposite of what was expected.

Since 2015, the ECB has also engaged in Quantitative Easing (QE), a bond buying program that pumps money into the economy. They have bought over €2.4 trillion in bonds with the objective to revive inflation.

Since last year, they have been reducing monthly asset purchases from €80 billion to €30 billion this year.

Yesterday, the ECB announced it will be ending their bond buying program. They said they will be halving that amount to €15 billion in September, down to zero by December this year.

The ECB also downgraded their growth future outlook, as you can see in the graph below.


Source: Bloomberg
[Click to enlarge]

The impact of QE and low rates

The effects of QE and low interest rates have definitely had an impact on the European economy.

Savers have felt the impact of long-term low interest rates. It has hit pensioners and those close to retirement particularly hard.

I mean, they’ve spent ten years getting zilch on their savings, that’s a long time…priceless saving time that they will never get back.

It has also pushed asset prices like stocks and property up.

And it’s made it cheaper to borrow money.

European governments have taken advantage of this cheap money era.

According to Eurostat, the government debt to GDP for the Euro area was 86.7% at the end of 2017. Some of the major European economies are quite indebted, as you can see in the graph below.


Source: Eurostat
[Click to enlarge]

While the ECB is looking at ending QE this year, they expect to keep rates the same until at least the summer of 2019, maybe even longer.

But inflation is rising.

CPI prices in May, around the Eurozone, increased by 1.9%, according to Eurostat, up from 1.2% in May. Mainly pushed by higher energy prices (6.1%) and food, alcohol and tobacco (2.6%).

Higher oil prices, low unemployment and increasing tariffs from the US trade spat could push inflation higher in the future. This could throw a wrench into the ECB’s plan.

Highly indebted economies could be vulnerable to rising rates.

And the ECB is coming in late on ending their stimulus plan.

The US Federal Reserve ended QE back in 2013 and began raising rates back in 2015. It’s looking at two more rate hikes this year.

Banks around the world are already starting to raise rates.

The ECB has been pushing to revive the economy for the last 10 years.

They looked at plans to stop stimulus back in 2017, when the economy was growing strong and they thought it could stand the end of the stimulus. Yet this year, the economy has slowed.

How will the different European economies react once they stop QE?

Your guess is as good as mine, dear reader.

But, in my opinion, it doesn’t look good.

Best,

Selva Freigedo,
Editor, Markets & Money


Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.


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