Published: Mar 10, 2016 12:38 p.m. ET
New targeted bank loans ‘very credit positive’
MarketWatch photo illustration/Getty Images, Everett Collection
ECB President Mario Draghi brings out the bazooka.
By
William
Watts
Deputy markets editor
European Central Bank President Mario Draghi and his policy-making compatriots delivered a bigger-than-expected stimulus plan Thursday, but also signaled that policy makers aren’t likely to further cut interest rates—sending a mixed signal to investors.
Markets were initially jolted after the ECB not only cut key interest rates and expanded the size and scope of the bank’s quantitative-easing program, but also announced a new round of cheap (in fact, the ECB could pay banks to take the money), long-term loans for eurozone banks—all part of a bid to reflate an economy that’s flirting dangerously with deflation.
See: Live blog recap: European Central Bank cuts rates, ramps up QE.
Financial markets reacted favorably—at least at first. European banks soared and the euro tumbled. European stocks SXXP, -1.66% in general and U.S. stock-index futures also legged higher, while European government bond yields, particularly on the periphery, dived.
But the euro soon turned around, rather violently, shooting higher versus the dollar about halfway through Draghi’s news conference. European stocks ended lower and Wall Street also headed south, tracking a drop in oil prices. Here’s what Germany’s DAX DAX, -0.59% did, closing down 2.3% to 9,498.15
The most interesting wrinkle was the ECB’s decision to launch four rounds of what are known as targeted longer-term refinancing operations, or TLTROs. That’s a mouthful, but essentially these are long-term loans (in this case with a maturity of four years) to banks that are specifically aimed at jump starting lending activity.
The larger a bank’s outstanding loan book, the bigger the loans. Initially, banks will borrow at 0%, but that will drop into negative territory—as low as minus 0.4%— the more the bank lends.
“In other words, the ECB could pay banks to borrow. This is very credit-positive,” said Jennifer Lee, senior economist at BMO Capital Markets in Toronto.
Increasing lending activity is crucial to spurring and, most important to the ECB, reflating the eurozone economy.
More QE
The ECB significantly expanded its bond-buying program. The decision to ramp up the size of its monthly purchases to €80 billion ($89.1 billion) from €60 billion wasn’t a huge surprise. Less widely anticipated was the ECB’s decision to expand the eligible assets to include investment-grade, euro-denominated corporate bonds from outside the financial sector.
“This is an extremely aggressive signal, since it shows that the ECB is willing to take on potentially significant credit risk in order to fulfill its mandate to raise inflation to its target,” said Bill Adams, senior international economist at PNC Financial Services Group.
Rate cuts
The ECB cut its benchmark lending rate to zero from a paltry 0.05% and, in a more closely watched move, lowered its deposit rate to minus 0.4% from minus 0.3%. The cut in the deposit rate was smaller than some economists had penciled in, but disappointment was partly offset by the refi rate cut and a lowering of the marginal lending rate to 0.25%. The negative deposit rate means banks pay the ECB to park funds overnight at the central bank.
Negative interest rates in Europe and Japan have confounded economists and investors. While designed to fight disinflationary pressures by discouraging money hoarding, many fear negative rates are counterproductive in that they can damage bank profitability and undercut lending activity.
The ECB’s decision to offset TLTROs at potentially negative rates is viewed as an attempt to address that issue:
No more cuts?
Draghi specifically pushed back against talk the ECB and other global central banks are running out of tools, telling reporters that ECB policy makers have shown “that we are not short of ammunition.”
But Draghi also said the ECB doesn’t anticipate a need to cut rates further. While that may sound like typical central-banker-speak after delivering a new round of stimulus, market participants appeared to take it as a signal that rates are near the lower bound, contributing to a sharp reversal by the euro EURUSD, +1.7002% and a selloff in European government bonds, sending yields higher.
Even with Thursday’s expansion, the ECB’s asset-buying plan is still smaller than those undertaken by the Federal Reserve and Bank of England, said Jonathan Loynes, chief European economist at Capital Economics, in a note. “Accordingly, we suspect that the ECB’s work is still not done.”
Low for a long, long time
Not surprising, ECB staff economists lowered their forecasts for both growth and inflation. Of particular note, in their first projection for 2018, they pegged annual inflation at just 1.6%—still well below the ECB’s target of near but just below 2%.
Draghi emphasized that rates are going to remain low for a very long time, but insisted that the eurozone economy isn’t in the grips of deflation. While the inflation rate fell to minus 0.2% in February and is likely to remain negative in coming months due to falling oil prices, it is expected to turn positive by year-end.
Nonetheless, a 1.6% inflation projection for 2018 was viewed as quite dovish.
Central bankers can’t save the world by themselves
Draghi has often emphasized that the ECB, despite his “whatever-it-takes” rhetoric, can’t do all of the heavy lifting. Draghi on Thursday amplified his call for a more aggressive fiscal response, specifically calling for increased infrastructure spending and other measures aimed at boosting productivity.
With the effectiveness of monetary policy “clearly diminishing,” Draghi “threw down the gauntlet to fiscal policy makers today, arguing for infrastructure spending while lowering the ECB’s own growth forecasts,” said Alasdair Cavalla, economist at the Center for Economics and Business Research, a London-based forecasting and analysis firm.
