December 19, 2018 / 10:07 AM / 6 months ago

Neutral interest rate for euro zone may be negative - research

FRANKFURT, Dec 19 (Reuters) - The euro zone’s “neutral real interest rate”, which neither stimulates nor puts a brake on its economy, may be negative, a study published by the European Central Bank showed, suggesting the ECB may have little room for rate hikes in the coming years.

Markets currently expect the ECB to increase rates for the first time in nearly a decade late next year or early in 2020.

A negative neutral interest rate, however, would suggest that the distance from current rates to a neutral rate may be smaller than previously thought.

That would mean the central bank has less room to raise rates without hurting economic growth and also less room to cut them before hitting the lower bound, where further rate cuts become ineffective.

While a neutral rate is imprecise and difficult to define, the U.S. Federal Reserve regularly defines its policy stance relative to the neutral stance, and some policymakers argue that tightening should stop around this level.

“Remarkably, most of our estimates of (the neutral real rate) for the euro area are currently negative, regardless of the type of model used,” the study, which does not necessarily represent the ECB’s opinion, showed on Wednesday.

“The protracted downward trend in (neutral rate) estimates indicated elevated risks of monetary policy becoming constrained by the lower bound on nominal interest rates in the future.”

The lower bound of rates effectively forces central banks to resort to unconventional tools including asset purchases, a controversial and not fully understood instrument.

With the ECB’s main rate at zero and inflation running around 2 percent, the real interest rate is now around minus 2 percent with market futures pointing to little change in this over the coming year.

While the study did not predict how this neutral rate will develop, it argued that it has been on a steady decline for decades and that weak productivity growth along with demographic factors may continue to exert downward pressure.

The decline in the working population and the drop in the number of workers in relation to pensioners are both increasing savings and would thus, all things being equal, push the neutral rate down further. (Reporting by Balazs Koranyi; Editing by Hugh Lawson)

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