Eurozone: ECB fires the bazooka, but will the new measures have the desired impact?
March 10, 2016
At its 10 March policy meeting, the European Central Bank (ECB) announced a comprehensive, yet widely unexpected, package of policy measures in response to persistent low inflation and weak global economic activity. The ECB decided to cut the refinancing rate and the marginal lending rate by five basis points to 0.00% and 0.25%, respectively. The ECB also decided to push the deposit rate further into negative territory. The deposit rate was cut from minus 0.30% to minus 0.40%. These policy announcements were also accompanied by an expansion and extension of the Bank’s asset purchase program (APP), also known as quantitative easing (QE), and a series of liquidity programs designed to boost lending. The ECB expanded its monthly APP by EUR 20 billion to EUR 80 billion, adding that the program is intended to run until March 2017, but that it could run even longer or until inflation returns to near its target of below, but close to 2.0%.
In order to strengthen the effectiveness of the APP, the ECB will purchase euro-denominated, investment-grade bonds issued by non-bank corporations. This decision, which was widely unexpected, expanded the list of assets eligible for regular purchases. Finally, the Bank stated that it will launch four new targeted long-term refinancing operations (TLTROs), with a maturity of four years. These measures are aimed at pushing banks to lend more money into the real economy. Financial institutions will be able to borrow up to 30% of their stock of eligible bonds and the interest rate will be fixed over the life of the loans at the rate of the main refinancing operations. Meanwhile, for banks whose lending exceeds what the ECB calls “a benchmark”, the interest rate applied will be even lower and may equal the deposit rate, now at minus 0.40%. Although the details are complex, the essential design of the TLTROs is that the ECB will pay banks for lending into the real economy, offsetting the potential negative impact that pushing the deposit rate further into negative territory could have on banks’ profitability margins.
Although markets had expected some policy easing—namely cuts in interest rates—at March’s meeting, the extension of the package of policy changes exceeded all expectations. The Consensus view among analysts and market participants is that the ECB’s measures are unambiguously dovish and well crafted, in particular the inclusion of corporate debt in the APP program as well as the new TLTROs. Regarding these measures, Ken Wattret, Co-Head of European Economics at BNP Paribas, stated:
“Including purchases of non-bank corporate debt is positive from a signaling perspective, as it shows a willingness to widen the range of assets [the ECB] will purchase (and note that the press release states ‘non-bank corporations’ and there is a large pool of assets which are classified as financial but which are not defined as banks – again we need more color on this from the press conference).”
ECB President Mario Draghi provided forward guidance by stating in a press conference that, “looking ahead, taking into account the current outlook for price stability, the Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.” However, Draghi added that as of now, and taking into account the expected impact on growth and inflation from the latest measures, the ECB does not anticipate further rate cuts. Nonetheless, analysts remain divided on whether interest rates have reached the bottom yet and whether the new easing measures have marked an end. Jan von Gerich, Chief Strategist at Nordea Bank, commented:
“Draghi clearly left the door open for further cuts, even if he thought no further cuts would be needed at the moment. Otherwise, the ECB should have cut more already yesterday. In the past, Draghi has given much stronger signals that rates have bottomed, only to cut again later, as conditions have changed. After all, Draghi also said that the experience we've had with negative rates, in our case at least, has been very positive.”
The combination of rate cuts, expansion of the QE program and a new refinancing scheme for banks was more aggressive than expected. Nevertheless, it remains to be seen whether the new policy measures have limitations. Criticism has emerged that the ECB’s QE program has not had the desired impact thus far. Therefore, there is skepticism that a EUR 20 billion increase in the APP will be a game changer this time. Moreover, although the TLTROs are well designed, the impact on credit across the region is likely to be limited due to demand-side constraints. Finally, the reaction of the markets—particularly the exchange rate—was timid following the announcement of the new measures. The euro had a brief decline shortly after the Central Bank announced the policy changes and increased its value against the U.S. dollar, which suggests that the foreign exchange channel has turned less responsive to dovish policy measures.
Author: Ricardo Aceves, Senior Economist