Thursday, June 5, 2014
ECB enters unchartered territory - with one foot
The ECB today ignited monetary policy fireworks. With rate cuts, new liquidity measures to enhance the transmission mechanism and some hints at further unconventional measures, the ECB presented a policy package of last hope. This was as far as the ECB could go without getting lost in the unchartered territory of QE. The trigger for today’s action was probably the downward revisions of the ECB’s staff projections and the wider fear that the recovery could falter and deflation could become a threat. As regards growth, the ECB now expects GDP growth to come in at 1.0% in 2014, 1.7% in 2015 and 1.8% in 2016. Risks to this outlook are still to the downside. As regards the inflation outlook, the ECB revised all its forecasts down and now expects inflation to come in at 0.7% in 2014, 1.1% in 2015 and 1.4% in 2016. The earlier pick-up in inflation towards the end of 2016 has also become less likely. In its latest forecasts, ECB staff expects inflation to be at 1.5% in Q4 2016. So what did the ECB actually decide? Rates. The easiest measures were the rate cuts on all major interest rates. The ECB announced a 10bp rate cut for the refi rate (to 0.15%, from 0.25%) and the deposit rate (to -0.1% from 0%). At the same time, the rate on the marginal lending facility was cut by 35bp (to 0.4%, from 0.75%), thereby making the rate corridor symmetric again. Targeted longer-term refinancing operations. This will become the ECB’s version of a funding for lending scheme, or better a reversed funding for lending scheme. According to the ECB, these TLTROs will have a maturity of around 4 years. Counterparties will be entitled to borrow, initially, 7% of the total amount of their loans to the euro area non-financial private sector, excluding loans to households for house purchase, outstanding on 30 April 2014. Lending to the public sector will not be considered in this calculation. The maximum volume of such TLTROs could amount to around 400bn euro. Two TLTROs will be conducted in September and December this year. Then, from March 2015 to June 2016, all counterparties will be able to borrow, quarterly, up to three times the amount of their net lending to the euro area non-financial private sector, excluding loans to households for house purchase, over a specific period in excess of a specified benchmark. The interest rate on these TLTROs will be fixed at the current ECB’s refi rate plus a fixed spread of 10 basis points. In our view, these TLTROs look like a reversed funding-for-lending scheme: the more lending commercial banks provide to the private sector, the more cheap funding they can get. Full allotment. The full allotment on all other liquidity operations was extended to December 2016. SMP sterilization. The ECB announced to stop the SMP sterilization. ABS purchases. The door for ABS purchases was kept open as the ECB decided to “intensify preparatory work related to” ABS purchases. According to ECB president Draghi, ABS would have to be based on real loans and not derivatives. Taken everything together, today’s package of policy measures is a strong one, underlining the ECB’s determination and willingness to act. However, as so often during the euro crisis, first-glance-enthusiasm doesn’t always last. Looking somewhat critically at today’s measures, the ECB has no guarantee that the economy and lending to the private sector can really be kick-started. The ECB is still dependent on banks. To some extent, the wish is still father to the thought. Nevertheless, with today’s measures, the ECB has at least sent three clear messages: i) the downward bias for rates is gone and rates have really reached the lower bound; ii) with the extended full allotment and the TLTROs the ECB rates will remain extremely low for at least another two years, if not even longer; and iii) if need be, QE – at least in the form of ABS purchases – could be started. Back in the summer of 2012, Draghi gave a whatever-it-takes moment for the existence of the Eurozone. Today’s measures are not yet a whatever-it-takes moment for the Eurozone economy but they are at least a good package which will give the Eurozone some additional monetary tailwind.