M FoundationEconomics, Banks and Payments | EuropeDigital Euro: Work In ProgressThe digital euro could be launched in 2027, and the ECB is currently in the first preparation phase – we examine the potential impacts for monetary policy, banks, and payments companies. Morgan Stanley Europe S.E.+Gabriela SilovaEconomist Gabriela.Silova@morganstanley.com +49 69-21662832 Morgan Stanley & Co. International plc+Giulia Aurora Miotto, CFAEquity Analyst Giulia.Aurora.Miotto@morganstanley.com +44 20 7425-5344 Alastair P NolanEquity Analyst Alastair.Nolan@morganstanley.com +44 20 7425-4620 Kerry ShawResearch Associate Kerry.Shaw@morganstanley.com +44 20 7677-4807 BanksEuropeIndustry ViewAttractiveDigital euro | The reasoning: The share of transactions for which cash was used as a means of payment declined from 79% to 59% between 2016 and 2022 in the Euro Area. At the same time, cryptocurrencies/stablecoins emerged to present a risk of becoming a new means of payments or store of value, as did payment providers that operate in the euro area but are headquartered outside of the European Union. These developments represent challenges to the monetary sovereignty of the ECB. As a result, one of the main goals of the digital currency is to ensure that the euro remains the monetary anchor in the euro area during the digital era. The ECB is currently in the first preparation phase until October 2025, which could eventually lead to the launch of the digital euro by 2027, at the earliest. Economics | No immediate impact: We do not expect the digital euro to have a material impact on the conduct of monetary policy, so we focus on implications for the ECB balance sheet. The main risks to monetary policy transmission from digital euro would come from large and sudden conversions of euro area bank deposits to digital euro. Safeguards being proposed for the digital euro, in terms of a cap on personal holdings, are aimed at minimizing this risk. In addition, the ECB has already outlined that the digital euro will be a non-interest bearing instrument, which removes it from the equation of having an active role in monetary policy setting. However, the digital euro will impact the composition, and most likely also the size, of the ECB balance sheet. We present a step-by-step process as to how the digital euro may be introduced to the economy, and how that could impact the ECB balance sheet. Banks | Design will be key – watch the cap. Depending on how the digital euro is designed, we think its (potential) introduction could impact demand for bank deposits, which are the cheapest form of funding for a bank. In this note we look at how this could affect banks' profitability. We estimate that a €3,000 cap – the limit the ECB seems to refer to most often – could, in a worst case scenario, lower deposits for Eurozone banks in aggregate by 7%, and ROE...
