Flickr, William Hook The ECB's near two-year long experiment with negative interest rates has been a complete failure, and deflationary pressures across the Eurozone are actually getting worse, not better, despite the efforts of Europe's central bank to try and boost growth.

"France and Germany hover close to stagnation," the economic research group Markit said this morning. UK manufacturing is only "slightly above the stagnation mark."

That's a scary thought — because if Europe was to fall back into recession it would be the worst possible scenario: a recession and deflation at the same time, in a world where interest rate reductions no longer boost economic activity.

The ECB was one of the first major central banks to take interest rates into negative territory when it did so in the summer of 2014.

The logic behind the move was simple. Making institutions pay — even just a tiny amount — to keep money with the ECB, would encourage them to lend, in turn boosting consumption and pushing inflation towards the 2% level so beloved by central banks. So far that inflation has failed to manifest itself, with the basic rate across the Eurozone at -0.2%, according to the latest reading yesterday.

Other central banks to apply minus rates include Denmark, Switzerland, Sweden, and Japan, but so far — other than a jump in Sweden's inflation rate last month — the tactic has failed to bump up growth or inflation.

This morning, Markit released its monthly snapshot of Europe's manufacturing sector, taken via the Purchasing Manager's Index. To say that they were poor would be something of an understatement. Manufacturers across the Eurozone got a score of 51.2, a fall from 52.3 in January, their lowest level in a year.

Markit gives a score between 0-100, with anything above 50 signalling growth, and anything below, a contraction. So while European manufacturing is growing, it isn't doing so with any real speed or confidence. UK manufacturing hit a 34-month low at 50.8. Add to that the fact that the two biggest economies in the euro currency area are, in the words of Markit, "close to stagnation" — Germany is at 50.5, and France at 50.2 — and it adds to a pretty bleak picture for the sector.

Overall manufacturing performance across the Eurozone slumped in February. Markit

Even more worryingly for the European economy, Markit says that "deflationary pressures have intensified" across the continent.



As Markit points out, manufacturers across Europe are being forced to drop prices across the board to try and boost sales. Here's Markit's chief economist, Chris Williamson (emphasis ours):

Prices are meanwhile being dropped as firms endeavour to boost sales, suggesting deflationary pressures have intensified. Input prices are falling at a rate not seen since July 2009.

So, despite the ECB spending more than 18 months trying to boost inflation by keeping rates in negative territory, the tactic obviously isn't working, and the evidence points to the policy doing exactly the opposite of what it's supposed to.

Goldman's Huw Pill, and his global economics team writing before the new Markit results were out, typified the new gloom coming from the major investment banks. "The slowdown in the global industrial cycle appears more marked than we had previously anticipated," they wrote.

However, many still believe that pushing rates even further into the negative is the best way to ensure inflation grows in the coming years. Indeed, it's impossible to know whether or not the inflation picture would be even worse had central banks not acted in this way. Amongst them seems to be Markit's Williamson, who said in the firm's release this morning (emphasis ours):

With all indicators – from output and demand to employment and prices – turning down, the survey will add pressure on the ECB to act quickly and aggressively to avert another economic downturn.

Next week, ECB president Mario Draghi will bring together the bank's Governing Council to decide what to do with interest rates. Draghi himself is still a huge believer in negative rates, and could well announce another rate cut.

At a press conference in January, Draghi hinted that the bank is looking to expand its policy of quantitative easing and further cut interest rates, to combat the stubbornly low inflation and growth currently plaguing Europe, saying: "It will be necessary to review and possibly reconsider our monetary policy stance at our next meeting in early March."

During that conference Draghi was dovish in his comments, saying that he expects the interest rates in the Eurozone, which currently sit at -0.3%, to stay low for an extended period of time.

However, he also struck a pretty reassuring tone, saying that the ECB has the "power, willingness, and determination" to ensure that Europe's economy succeeds, and that there are "no limits" to what the bank will do to ensure this.

Market speculation is that Draghi will look to cut the ECB deposit rate by another 0.1% to -0.4%. Goldman Sachs also predicts that Draghi is set to announce plans for a €10 billion per month increase in the ECB's QE programme, and an extension of QE until at least September 2017.

Draghi is expected to keep cutting rates, despite HSBC, JP Morgan, Goldman Sachs, Morgan Stanley, and others all arguing that negative rates have failed in their goal, and are actually making deflation even worse.