Central banks across the world have a provision for more interest rates cuts before they start doing more damage. The European Central Bank (ECB) made its interest rate negative almost five years ago as a way of helping curb concerns of deflation in the eurozone. This was to be a temporary move meant to check the levels of inflation.
Lower rates could affect regional banking
US interest rates have also been reducing and there has been growing concern among investors on how detrimental this could be for regional banks. According to Citigroup, the banks are anticipating more interest rate cuts almost four times from the Federal Reserve before the year ends. In the short term, the Federal Reserve’s target will range from 0.75% to 1% relative to the current 1.75% to 2%.
Because of the lower interest rate, bank stocks this year have been on a roller coaster with a lot of volatility for the S&P 500 banking group as shown in the chart.
On Tuesday analyst Keith Horowitz indicated that there are macro headwinds associated with the lowering of rates and that presents a huge drawback for regional banks. Horowitz argued that the current rate cuts are not priced into regional bank stocks.
Banks expect fewer returns because of lower rates
Rates cuts are a disadvantage to banks because it means that the assets they buy will give fewer returns and borrowers will be paying less interest rate. Equally, it gives the existing borrowers an incentive of refinancing at lower rates. This comes at a tome most banks are paying less interest rate on deposits meaning there is limited room to minimize what they pay as rates continue to fall.
As part of the ECB’s monetary easing policy, last month they slashed key rate by 0.5% which has raised concerns from bankers. More concerns game from Germany whose banking sector has been ailing. According to Christian Sewing, the CEO of Deutsche Bank negative rates are detrimental to banks and they are threatening the banking system. Commerzbank CEO Martin Zielke also said that the ECB policy is unsustainable and insensible.
Robert Holzmann the Austrian National Bank Governor has also been critical of the monetary policy. He said that the policy is wrong and it needs revision or having a new policy in the future. Holzmann indicated that the policy received resistance from European banks and was hoping that current ECB chief Christine Legarde will consider a new approach.