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ECB is creating a monster with zero interest rate policy

Depositors and investors will by now realize that the zero interest rate policy being pursued by the ECB is having a disastrous effect on pensions, savings, and investments. In his final meeting as head of the ECB Mario Draghi cut rates further and re-launched the printing press i.e. Quantitative Easing. Why?

Well, it is in response to very poor data showing Germany heading into recession along with France and Italy, basically the core of the Eurozone. Trade tariffs are mainly to blame which have caused a slowdown in China and the US. We have also reached the end of an economic cycle. It can be hard to see that from Ireland where we are enjoying high levels of growth and full employment. Indeed we are suffering from a booming economy which is causing a housing crisis and strains on the health service.

Mario Draghi has pursued a strategy of easy monetary policy since taking office eight years ago. His only mandate was to raise inflation towards a 2% target, it was never achieved. One could argue low-interest rates and the printing of money have had little effect on economic growth. Sure they have raised the value of stock markets and bonds but have failed miserably to ignite any worthwhile recovery in Italy and very little in France. We are heading back into recession, not quite as bad as 2008 because the banks are better capitalized but this recession may be longer seeing as the medicine for recessions (lower interest rates) has already been taken and failed. Mario, who understands the failure of easy monetary policies but is paralyzed to do anything else, is now urging governments to undertake fiscal policies (lower taxes, spending programs) to aid recovery this time around. Remember last time it was austerity!

Taking over the reins from Mario is Christine Lagarde current head of the IMF. If you think Mario was a fan of stimulus measures Christine may make him look conservative, she is the person who provided all the bailouts to Greece etc. and is quite likely to go on a serious money printing exercise combined with even lower interest rates. After all, she will need to make an impression as she takes over a Eurozone plunging into recession. I have heard predictions of interest rates as low as minus 3%.

Sabine Lautenschlager, the German representative on the ECB has had enough and resigned. She feels this policy has failed and it not worth pursuing further. It will lead to tensions on the board but we are a long way from a change in strategy.

I am not in the minus 3% camp myself but we already have minus deposit rates in Denmark and they are coming here soon. If a zero/negative interest rate policy is not fixing the economic malaise what is it really about? The reality is; zero rates are a tax on savers and investors to offset the borrowing cost of corporates and governments. The Irish government can fund maturities of the national debt for ten years at 0%, amazing!
The nasty effect of course, is it is destroying people’s wealth into retirement. If you have a conservative pension fund, 60% is likely to be in zero yielding bonds, 40% in equities which historically have an average annual return of 7%. Combined that is a gross return of 2.8%. Fees and charges are in the region of 2% and inflation is 1.5%. You are in effect losing value year by year without any chance of your pension pot growing.
If you are a depositor you earn 0% but with inflation, the value of your savings will depreciate by about 20% in a decade.

There is a huge challenge for individuals with funds on deposit, funds in a pension, or with investments. If you retired on a €500,000 lump sum at age 60 and are afraid to invest, you are quite likely to live 35 years or so, your nest egg earns you €14,300 per annum. This is the stark reality of zero interest rates, individuals once considered wealthy are now poor.

Eventually, underperforming pensions and savings are going to cause a headache for governments as retirees will have to rely increasingly on the state for support. With poor aging demographics (fewer people working supporting greater numbers in retirement) this problem is looking more like the climate crisis, not so evident now and easy to ignore but a monster in the future.

Peter Brown is Head of Education at IIFT and Managing Director at Baggot Investment Partners (Baggot.ie)

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