With euro-area inflation once again below zero and concerns mounting over the state of the global economy, ECB President Mario Draghi and his colleagues are considering whether monetary policy needs to give more impetus to the currency bloc’s recovery. The chief concern is that negative interest rates, especially if cut further, might squeeze banks’ profitability to the extent they pull back on lending to companies and households.

Draghi “should worry about the implications for the banking system,” Mark Burgess, chief investment officer for EMEA at Columbia Threadneedle Investments, said in an interview in Frankfurt on Wednesday. “He needs a healthy banking sector.”

One of the most straightforward measures would be to cut the deposit rate from the current minus 0.3 percent, while implementing a two-tier system. Banks would pay the negative rate only on the portion of their funds parked at the ECB that exceeds a certain threshold.

Such a facility, similar to that used at other central banks with negative rates including the Swiss National Bank, would be simple to implement in the euro area, the people said, asking not to be identified as the discussions are private.

An executive at a major euro-area bank, who also asked not to be identified, said he doesn’t know whether lenders could handle a tiered deposit rate immediately. It would largely depend on the design, he said.

While the Frankfurt-based ECB has operated a deposit rate below zero since mid-2014, it so far hasn’t taken any direct steps to offset the potential hit to bank profitability. A reduction in the rate of at least 10 basis points is fully priced in by investors, data compiled by Bloomberg indicate, based on swaps on the euro overnight index average.

Eoin Treacy's view

We’ve written quite a bit about the challenges negative deposit rates pose for the banking sector particularly in Japan and the Eurozone. One of the issues this poses for the ECB is that the whole purpose of negative rates was to encourage banks to lend. However they are inhibited from doing so because of the cost of the program as well as the additional burden of regulations imposed since the financial crisis. The prospect of the ECB altering its policy to remove some pressure on the banking sector would be a positive development. 

The DJ Euro Stoxx Banks Index found at least near-term support three weeks ago and a reversionary rally is now underway. When we look at the long-term chart for some additional perspective we are presented with a V-bottom, in 2009, with right hand extension. The six-year range that continues to unfold represents a typical sleeper base that could last for a lengthy period. The volatility evident within the base is also characteristic and impressive peak to trough swings are to be expected. It will need to hold the 75 area if base formation development is to continue to be given the benefit of the doubt.