Sunday 18 February 2018

Why the ECB's taking an interest in dumping €500 notes

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Click to view full size graphic

Jeff Black

The days of the €500 note could be numbered, and not just because it's the favourite of crime lords everywhere.

As the European Central Bank (ECB) ponders pushing its deposit rate further below zero, it finds itself aligned with authorities wanting to curb a means of tax evasion and terrorism financing.

If, as mooted by ECB President Mario Draghi, policy makers abolished the region's most-valuable bank note, they'd also help remove a major barrier to pushing interest rates lower.

Deeper negative rates could at some point push lenders to move money out of their central bank deposit account and into cash rather than endlessly suffer losses. In the Eurozone, where the €500 note means the equivalent of $1bn of currency only takes up three cubic meters, scrapping that denomination would make it harder to hold large amounts of currency.

Abolishing the largest notes "would allow some further cut in the level of nominal interest rates because it would make the storage of cash considerably more expensive or difficult", Charles Goodhart, a former policy maker at the Bank of England and a professor at the London School of Economics, said.

"There's a reasonable chance that we might get an upper limit on the denomination in line with that which any respectable country ought to provide."

With the Bank of Japan taking its own first foray into negative interest rates last month, a once-impossible-sounding policy tool is becoming mainstream in a world where conventional rate cuts have been used up but inflation is weak and growth fragile. While policy makers in Frankfurt can add to their existing programme of asset purchases if need be, they're also signaling they're willing to cut their deposit rate below the current minus 0.3pc.

While that's happening, a new push is under way by European governments to stem the ability of money launderers, tax evaders and terrorists to use cash for their activities, in part prompted by the attacks in Paris in November.

One stream, as promoted by the German government to the dismay of the general public, is an EU-wide upper limit on cash payments. Cash represents 80pc of retail payments in Germany, and the government initiative prompted an angry petition by 'Bild' newspaper this week.

The other concerns the abolition of the €500 note. "That's a decision for the ECB Governing Council," Bundesbank President Jens Weidmann said at a press conference in Paris on Tuesday. "Both follow the same goal, which is to curtail illegal activities."

Weidmann also said the outlook has clouded and that the ECB will discuss its response at its meeting in March. Analysts are already placing bets on a fresh cut in the deposit rate, including JPMorgan Chase & Co's Greg Fuzesi, who forecasts two 20 basis-point reductions this year. A paper by Fuzesi's colleagues, Malcolm Barr and Bruce Kasman, suggests that with tweaks to reserve management the ECB could ultimately go as low as minus 4.5pc. That would bring the ECB close to the furthest below zero that any major central bank has ever gone, and potentially raise questions about whether such a level could be implemented without lenders coming to the conclusion that it would simply be better to bunker banknotes.

Switzerland and Denmark have implemented a lower rate, minus 0.75pc. While there's little evidence of cash hoarding there, it's not clear how such a policy would play out in the euro area. (Bloomberg)

Irish Independent

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