The Effects of ECB's Negative Depository Rates

Mario Draghi has lowered interest rates and marched into 'uncharted territory' by setting Central Bank depository rates to -0.10%. As a result, banks have to pay interest to store their cash at the ECB. This forces banks to push excess liquidity into circulation and into the hands of lenders, thus sounds the plan. Negative interest rates are not fully uncharted; Switzerland has used this policy tool aggressively in the '70s and the Swedish Riksbank and Danmark's Nationalbank even very recently. Although the Swedes haven't used this instrument in full effect, lessons can be learned from Denmark, who have recently ended their exercise.

Enter the Currency Wars

The most pronounced effect of negative interest rates  measure is to suppress currency exchange rates.
In order to curb the capital inflows that inflated the Danish Crone, the Bank of Denmark set their deposit rate to negative in July 2012. The large influx of money undermined their efforts to keep the Crone pegged to the Euro.

The ECB's Mandate

All of Mario Draghi's actions need to respect the ECB's principal mission. This is to keep inflation near 2%. Since the Eurozone faces a deflationary threat, drastic measures seem necessary and justified. The debasement of the Euro might stimulate possible drivers to inflation, but this is far from certain. This experiment may also backfire...

European citizens may already prepare for even lower interest on our savings. It is up to all actors within the Eurozone if riskier assets are preferred over low yielding savings deposits.

Problable Effects

So what does history tell us?

1. Lower interest rates will be only partially passed through to consumers and to a larger extend to corporate deposits and/or service fees.
2. Negative interest rates prove to directly affect currency exchange rates. 
3. Chances for a credit crunch are as big (or slim) as changes for increased money flow.
4. Government and asset backed bonds interest rates may decline.

Whatever the ECB is orchestrating, it's (un)intended effects are still to be seen.

"It is an axiom of central banking that the banking system itself cannot reduce the aggregate amount of its central bank deposits no matter how many loans are made because the funds loaned by one bank eventually are redeposited at another. Is it reasonable for the central bank to impose a tax on deposits held at the central bank when the central bank itself determines the amount of such deposits held by banks and the banking system? Perhaps these and other considerations caused European Central Bank President Mario Draghi in a recent press conference to label negative deposit rates "uncharted waters" and dismiss any possibility that the ECB would consider it."

- St. Louis Fed, januari 2013

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Sources:
http://www.bankofengland.co.uk/research/Documents/ccbs/cew2013/presentation_lynggard.pdf
http://research.nordeamarkets.com/en/files/negative-rates-April13.pdf
http://www.stlouisfed.org/publications/re/articles/?id=2316