Some of the measures may help to improve the flow of credit to the real economy, but this may not happen in the near-term, and lending volumes may continue to reflect subdued demand. Thursday’s announcement supports our view that eurozone authorities and policy-makers are alive to the continuing risks to the bloc’s long-term recovery and adjustment.
The ECB did not announce quantitative easing (QE), but President Mario Draghi said that the central bank "will act swiftly with further monetary policy easing" if required, and that ECB’s Governing Council "is unanimous in its commitment to using... unconventional instruments within its mandate" to counter the risk of too prolonged a period of low inflation. The ECB will be suspending sterilisation of bond purchases under its Securities Market Programme, which arguably represents a step towards QE, albeit on a very limited scale.
Nevertheless, eurozone inflation is already low, with annual HICP inflation slowing to 0.5% in May. The ECB reduced its own projections for inflation in 2014, 2015, and 2016, down to 0.7%, 1.1%, and 1.4% respectively. Low levels of inflation will have a pernicious effect on debt dynamics and make the competiveness adjustment between eurozone economies more challenging. Very low inflation is one reason that our public-debt/GDP projections for the eurozone have deteriorated since 2012 (although other variables have a greater impact).
The breadth of the ECB’s announcement is notable. It includes rate cuts including a move to negative deposit rates, measures to provide banks with cheap funding, and further work on potential asset-backed securities purchases. This may be more effective than announcing measures in isolation. For example, we do not think that a mildly negative deposit rate alone would have been transmitted into a meaningful stimulus to the real economy, as banks have grown accustomed to receiving very low returns on money deposited with the ECB versus lending elsewhere.
The targeted longer-term refinancing operations (TLTROs) may spur bank long-term lending to SMEs, an important part of most eurozone banks’ business model. It should help lower longer-term funding costs for banks since the interest rate will be fixed at 10bp over the prevailing main refinancing operation (MRO) rate at the time of take-up. It is also positive because the four-year facility would help banks lengthen their funding maturity profile to meet the net stable funding ratio requirement under Basel’s new liquidity rules. But lending appetite is likely to remain subdued until the banks are through the stress tests and capital expectations are known in 4Q14. The TLTROs could be positive for bank lending in 2015 once these points have been clarified, depending on demand.
As we have previously said, ABS purchases, when announced, could support lending to SMEs, but whether this happens, and whether this lowers the cost of credit for SME borrowers, would depend on the price the ECB was willing to pay.
The ECB on Thursday cut its main refi rate to a fresh record low of 0.15% and lowered the rate on the bank deposit facility to -0.10%, effective as of 11 June, taking it negative for the first time. It also announced TLTROs potentially worth around EUR400bn that will mature in around four years. The ECB will step up preparations to buy ABS, its MROs will continue as fixed rate tenders with full allotment.
