By Nigel Stephenson and Marius Zaharia
LONDON, Nov 5 (Reuters) - When the European Central Bank cut its deposit rate into negative territory last year, many analysts warned that the move would push money market rates so low that it would discourage bank-to-bank lending.
In fact, data shows overnight lending activity in euro zone money markets — a proxy for unsecured lending volumes — was largely unaffected by negative rates.
It has fallen sharply, however, since the ECB launched its trillion-euro bond buying programme in March.
While negative deposit rates were expected to hurt the supply side of interbank credit, the quantitative easing (QE)programme has hurt demand, as banks are awash with the money the ECB has pumped into the market via bond buying.
For now, the abundance of cash seems to be having a mild positive effect on the euro zone economy, with bank lending to businesses and consumers ticking up from a small base. Whether more QE will accelerate that recovery remains to be seen.
But there are heavy long-term risks attached to the ECB supplying most of the liquidity to the banking sector, rather than just being an occasional lender of last resort.
Banks fund themselves in many ways: They can access capital markets, tap into interbank markets, go to money market funds or take part in the ECB’s regular lending operations.
As most of the cash is now supplied cheaply by the ECB, activity in the other liquidity-providing industries could shrink to the point where the viability of their business models is questioned.
The longer the ECB’s QE programme runs, the greater the risk that the banks and, implicitly, euro zone economies become addicted to its cash as other sources dry up. It also becomes harder for the ECB to exit its ultra-easy monetary policy.
“In the short-term, it’s not a problem and the volumes could go down even further,” said Elwin de Groot, senior market economist at Rabobank.
“But it would become a real problem in the longer term when they decide to change their policy and start talking about draining liquidity.” (Graphic by Nigel Stephenson; Reporting by Marius Zaharia; Editing by Hugh Lawson)