When the ECB surprised markets by cutting its deposit rate to zero in the summer of 2012, it was the last thing long-suffering money market funds needed.
Already facing the harsh glare of regulatory scrutiny following the collapse of the Primary Reserve Fund in the wake of the Lehman Brothers bankruptcy, and struggling to make returns after years of rock-bottom interest rates, the ECB’s decision led banks to plough their surplus liquidity into the paper of top-rated borrowers, further reducing the returns available in the market and raising questions about the viability of the whole money market fund model.
Barclays estimated at the time that the euro CP market could shrink by 20% as a result — certainly, it left money market funds rethinking the model of buying short term, highly rated assets that had been their lifeblood since their creation.
Many providers pulled funds as investors took their cash elsewhere.
While dealers and fund providers are less concerned that moving to a negative deposit rate would have similarly detrimental effects — the damage was already done by the decision to move to 0%, they argue — one cannot say for sure. It is hard to imagine that rates won’t move at least slightly lower, and with years of meagre returns, a little more damage could have an outsized impact.
Denmark did switch to a negative deposit rate in the summer of 2012 (until April of this year), but with the greatest of respect to that country, the cross-border European money market is a much larger and less predictable beast.
It seems strange for the ECB to use an option that is unlikely to impel banks to lend to small and medium sized enterprises but that does have an outside chance of kicking money market funds while they are down.
With those funds an important source of short term liquidity to banks and corporations, jeopardising a big investor base when Europe’s economy is still in the early stages of recovery is a risk that was not worth taking.