In a key week for the Eurozone, where the European Central Bank (ECB) has implemented the eighth consecutive interest rate cut, to levels of 2% in the case of the deposit facility, Silvana Tenreyro, professor of Economics at the London School of Economics, analyzes the consequences of negative interest rates on the economy, if it could happen again in Europe, and above all, why the aging population puts pressure on rates to decrease. Tenreyro talks with EL MUNDO within the framework of the JEEA-Fundación BBVA 2025 Conference that took place in Madrid last May.
Question. Is it feasible for a negative interest rate scenario to occur again in the Eurozone?
Answer. It is not in my central scenario, but it is within the probability distribution. It is possible that a market shock could force the central bank to make this decision. One must be prepared for extreme events such as increased global uncertainty. Interest rates are around 2% in the Eurozone; however, in Switzerland, they are above 0.25%, and it is not unlikely that they may resort to negative rates, especially now that their currency has appreciated significantly against the dollar [due to money seeking refuge in the Swiss franc]. This is already being discussed to stimulate the economy and to prevent deflationary situations that could exacerbate a recession.
Q. During the time of negative interest rates, bank deposits did not earn interest. When this situation changed starting in September 2022 with the first rate hike by the European Central Bank (ECB), people somehow expected a liquidity war, but it never happened. Will the battle for liabilities never return?
A. Deposits are an important source of funding for banks, particularly for bank loans. Over time, the role of these deposits in funding compared to the financial market has decreased (it would be split around 70% to 30%). It is not a significant factor, but it does not play the same role it did 40 years ago. Deposit rates will generally be below policy rates. Given the decline in the equilibrium interest rate, it is natural for deposit rates to also fall, as have loan rates over the past 40 years. Deposits with high returns are more of an exception.
Q. The banking model in Spain is closely tied to savers, rather than to funding sources like investment or the capital market. That is why the drought of a decade with interest rates at 0% or negative was so concerning. However, the banking sector managed the situation well. Could it happen again that banks are caught off guard by 0% rates, or have they learned their lesson?
A. There is much more regulation since the financial crisis, and banks' liquidity needs are better understood, making them much better prepared. This was evident during the pandemic. We cannot rule out situations that are not part of the plan. A very deep crisis could shake the foundations of the financial system. It is important to remember that a significant threat is partly technological. This was seen in the U.S. in its recent mini banking crises when it became apparent how easy it was for depositors to move their money to other financial assets, making banks that relied on those deposits very vulnerable. Europe is technologically behind, but in the future, this could also pose a threat to stability, and banks and regulators will have to consider the greater flexibility of deposits. This could happen if we follow U.S. patterns, which is partly what happened with Silicon Valley Bank.
Q. During the period of negative interest rates in the eurozone, some banks even charged individuals for depositing their money with them, something that in Spain was limited to businesses. Should people understand that this could happen again?
A. Yes, it is possible. Many banks in the rest of Europe have already done so. In Denmark, they charged families with large wealth accounts. If a very deep recession occurs, the cost will have to be shared in society, and banks could end up passing part of the cost to families.
Q. Japan is a clear example of a country accustomed to living with symbolic interest rates of 0%, but it doesn't seem to have helped them much.
A. It was an economy that remained stagnant for a long time. It did not have the courage, like Europe, to go to more negative interest rates, nor did it implement asset purchase levels; therefore, the stimulus was very timid, and the economy remained in a state of stagnation. There are other issues that will affect Europe in the future, such as the aging population. These are different circumstances, but it can serve as an example that if sufficient stimulus is not provided to the economy, it can remain stagnant.
Q. Does the aging population also affect the drift of interest rates?
A. It can affect and also explains why equilibrium rates historically declined. Obviously, these demographic trends are global and are one of the reasons we saw this drop in global interest rates. The idea is that if we have longer lives, we need to save more to sustain that longer retirement period, increasing demand for safe assets and putting downward pressure on interest rates.