Drug dealers, money launderers and assorted cash-only criminals love the convenience of the 500 euro note. Will bankers also soon be clamouring for wads of the high-value bill? The question arises because the European Central Bank might have to lower interest rates further to revive growth. Business surveys this week are likely to show the euro zone economy remaining flat on its back in August after contracting by 0.2 per cent in the second quarter.
But the ECB has already cut to zero the interest it pays banks on excess reserves. So driving the deposit rate into negative territory-charging banks for the privilege of parking surplus funds-would force lenders to weigh up the alternative of withdrawing cash and stashing it somewhere safe. The idea sounds outlandish. Not so. ECB Executive Board member Benoit Coeure addressed it back in February.
"Given the costs associated with holding large amounts of banknotes, it is likely that significantly negative interest rates would be required to trigger a switch from money holding to investment in banknotes," Coeure said. Since then, the economic recovery the ECB was anticipating has failed to materialise, prompting the move to a zero deposit rate and leading economists to take a closer look at the cost of warehousing notes.
"The physical storage would be easy; if withdrawn as 500 euro notes, 1 billion euros (plus two big security guards) would easily fit into a VW Golf and the cash into existing bank safes. Harder to gauge are the inconvenience and insurance-type costs, which will affect banks' response," Greg Fuzesi of JP Morgan wrote in a note.
Lasse Holboell Nielsen, an economist with Goldman Sachs, has examined the case of non-euro member Denmark, whose central bank set a deposit rate of minus 0.2 percent over a month ago, to tease out the implications for the euro zone. For a bank with 40 billion Danish crowns ($6.60 billion) on deposit, he reckons it would make economic sense to take out cash once the interest rate drops below -0.52 per cent or -0.65 per cent, depending on the fixed-cost assumptions for insurance, transport and vault rental.
Because Denmark's central bank has not encountered any unexpected fallout since it went negative, Nielsen concludes that it could cut the deposit rate by another quarter-point. And based on Denmark's experience, he judges a negative deposit rate at the ECB of 0.25 percent is quite feasible.
Steen Jakobsen, chief economist with Saxo Bank in Copenhagen, said he expected a weak euro zone purchasing mangers' survey on Thursday would ratchet up the pressure on ECB President Mario Draghi to act. "It will support the argument that Draghi feels the need to do something about the monetary transmission mechanism because the numbers will just continue to weaken," Jakobsen said. (Reuters)
