Friday, 6 June 2014

The ECB answered... in part but ready to do more

In my article on the eve of yesterday's ECB meeting I argued that the ECB must take concrete measures to keep the Euro area economy from moving too close to deflationary territory and to move inflation gradually nearer to its target of below but close to 2%.

I explained the following menu of choices and below each in red I explain what actually the ECB has delivered following its meeting yesterday:

a. reduction in official interest rates - but these are already every low and a shave of 0.15% is symbolic but hardly effective.

The main refinancing rate was reduced from 0.25% to 0.15%.   A shave of 0.10% which is symbolic more than tangible.

b. charging banks negative interest rates for excess reserves parked that the ECB rather than used to lend to private sector to promote investment and consumption.
The deposit rate it pays to banks for their excess liquidity has been reduced by 0.10% from 0% to minus 0.10%.  The move to negative interest is a record to be noted piercing through the zero bound.  As this is uncharted territory the ECB was prudent to test the waters by a very small breach to the zero bound limit.   Its effectiveness will mostly be through the foreign exchange markets by weakening the exchange value of the Euro as speculators avoiding keeping idle Euro in expectation of exchange gain if they have to incur negative interest charges.

c. offering banks generous long term repo facilities to give them cheap funds to lend longer term to industry and private economic operators.
Various measures were announced under this heading.  Sterilisation of the securities market programme was suspended and this will on its own inject some EUR 165bn into the money markets.  The credo that increased money supply will automatically lead to increased inflation will be set to test. 

The collateral framework was eased by lowering acceptnce criteria by including special assets such as credit claims to accessing liquidity windows offered by the ECB making it easier for banks to access cheap liquidity.  Targeted Long term Refinance Operations ( TLTRO) for some EUR 400 bn were launched for 2014 offering banks cheap long term funding conditional on it being channelled to lend to non-financial sectors.

d. consider some sort of asset purchases ( through quantitative easing) especially if directed to lift assets from bank's balance sheet - through securitisation of their loan book - to allow space for new lending without demanding fresh capital

As anticipated the ECB considered quantitative easing (QE)  a bridge too far but it pre-announced that an  Asset Backed Securities purchases program is in the works to launch if further monetary support is needed.  The ECB needs time for setting up the financial infrastructure to securitise bank assets to make this particular QE measure effective in the Euro area without crossing the Rubicon of using QE for buying sovereign bonds.

The ECB has delivered as much as it could at this point. Whether this will be enough depends a lot not just on how much these measures repair the broken down monetary transmission mechanism to channel credit where needed, mostly to SME's in crisis countries, but also on how much the EUR will weaken against the USD, GBP and Yen on the foreign exchange market as investors have to come to terms with negative interest rates which could be increased ( made even more negative) if necessary.

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