Negative rates to erode bank profits, says Morgan Stanley

It argued that negative rates are a “dangerous experiment” as they not only erode profits, but also give a disincentive to cross-border Eurozone lending and risk non-linear effects on bank funding.

“This is all contrary to the ECB’ desire to ease credit conditions and support financial stability,” it said.

MS said that beyond a 10-20 basis points rate cut, the impact on earnings would be exponential.

It said experience from Sweden, Denmark and Switzerland suggests banks will reprice lending and charge higher fees to mitigate.

However, the weaker state of lending and contracts linked to Euribor means the ability to reprice is lower in the Eurozone.

“As long as the lower bound is not clear, it's difficult to predict how bank stocks will perform, as -1% negative deposit rates (as some senior policy makers have suggested) would materially impair net interest income in the euro area.

“For banks, we argue the best scenario would be no cut in the depo rate, and some expansion of ECB buying programmes.”

As far as FX is concerned, it reckoned further rate cuts from the ECB will have much less of an effect on the euro relative to the initial move below zero.

“Most of the EUR impacting portfolio adjustment following the first cut to negative is already complete,” it said, adding that valuations are also very different now compared to summer 2014.

“With the costs to cutting higher, the returns diminishing, and valuation already cheap, we think there is little that the ECB can do on the rates side to materially move the common currency.”