LONDON (Reuters Breakingviews) - The European Central Bank is heading for somewhere between a rock and a hard place. Weakening economic activity is raising the chances of President Mario Draghi’s successor following in the footsteps of the Bank of Japan, which has kept policy rates ultra-low for two decades and adopted ever more radical measures. A “Japanisation” of monetary policy would exact a heavy toll on Europe’s lenders, which would only make the central bank’s job harder.
New evidence that the euro zone economy is slowing came on Friday when a purchasing managers’ survey showed factory activity contracted at the fastest pace in nearly six years. That makes the ECB’s inflation target, of just below 2 percent, more elusive. More bond purchases, and keeping official rates low may not fix the problem, as the BOJ’s experience shows. No wonder some ECB officials wonder in private whether they will have to copy the BOJ’s policy of controlling the yield curve, or even buying equities.
Japan shows what ensues. Market distortions are a lesser evil. A bigger one is how low rates and a flattened yield curve have hurt lenders. Japanese banks’ average net interest margin, the difference between the rate at which they borrow funds and lend them out, has fallen to 0.9 percent from 1.5 percent in 2000, while their return on equity has roughly halved since 2005, to 5 percent, Deutsche Bank calculates using FactSet data. That gives a sense of the pain that lies ahead if the ECB emulates BOJ chief Haruhiko Kuroda. The average net interest margin for lenders included in the STOXX Europe 600 Banks Index is around 1.65 percent, according to Deutsche. Valuations also have plenty of room to turn more Japanese: the average price-to-book ratio for banks in the same STOXX 600 Index is 0.71, compared with 0.46 for Datastream’s index of Japanese banks.
The ECB can say lenders’ health is not its primary concern. True. But in the euro zone, as in Japan, companies depend on banks for three-quarters of their financing requirements, with households’ reliance even higher, at nine-tenths, according to Deutsche Bank. What’s bad for banks may therefore end up being bad for the economy. Kuroda has grown more sensitive to the impact of his policies on lenders. The ECB has the late mover’s advantage of being able to learn from his experience.