Low Yields: an Unintended Consequence of Central Bank Policy

An article from the Financial Times last week, citing data from Bank of America Merrill Lynch, highlighted an unintended but important consequence of European Central Bank policy. Last June, the ECB imposed a penalty on bank deposits by charging financial institutions a fee for parking reserves there. The hope was that banks would react to the deposit charge by pulling their excess cash out of the ECB and making loans to consumers and small businesses, thus stimulating economic growth. Banks have indeed pulled their reserves from the ECB. However, instead of making loans they have chosen to purchase safe-haven European Sovereign bonds. This incremental demand has pushed many short-term sovereign yields into negative territory, meaning that buyers are paying borrowers to purchase their debt. This is essentially another type of fee for parking cash. The volume of negative yielding Eurozone government debt has reached a record 1.2 trillion euros, which equates to one-quarter of all outstanding Eurozone government debt. The two implications from this development are clear: 1. The outlook for the Eurozone economy is grim if banks would rather pay to park cash than make loans, and 2. Low yields in the Eurozone are likely here to stay for the foreseeable future, which will likely keep a cap on U.S. yields as well.