The ECB Bazooka of Thursday, March 10, 2016

Dear PGM Capital Blog readers,

On Thursday, March 10, 2016, the European Central Bank (ECB) during its monetary policy meeting took the following monetary policy decisions:

  • The interest rate on the main refinancing operations of the Eurosystem will be decreased by 5 basis points to 0.00%, starting from the operation to be settled on March 16, 2016.
  • The interest rate on the marginal lending facility will be decreased by 5 basis points to 0.25%, with effect from March 16, 2016.
  • The interest rate on the deposit facility will be decreased by 10 basis points from -0.30% to -0.40%, with effect from March 16, 2016 as can be seen in below chart.
  • The monthly purchases under the asset purchase program will be expanded to €80 billion starting in April.
  • Investment grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets that are eligible for regular purchases.
  • A new series of four Targeted Longer-Term Refinancing Operations (TLTRO II), each with a maturity of four years, will be launched, starting in June 2016. Borrowing conditions in these operations can be as low as the interest rate on the deposit facility.

In a statement the ECB president Mario Draghi said the decision to cut rates reflected an outlook of low inflation and economic weakness in the eurozone.

The ECB’s target is to keep inflation just below 2% – seen as a healthy level for economic growth.

Mario Draghi, said also interest rates would stay low for “an extended period” and he kept open the option of a further cut. But he added his voice to growing unease about negative rates among top central bankers, saying he did not anticipate pushing deeper into negative territory, partly because of the impact on banks.

“Does it mean we can go as low as we want without having any consequences on the banking system? The answer is no,” the ECB president said.

His comments on rates triggered a surge in the euro to US$1.12, a near 2 per cent rise on the day, after it earlier plunged on the news of the ECB’s measures as can been from below chart.

Analysts interpreted the measures as a recalibration of the ECB’s armoury, putting more ammunition into reinforcing the eurozone’s economy and less into weakening the currency.

As can be seen from below chart, after an initial fall, the yield on 10-year German Bond rose 6 basis points to 0.30 percent while equivalent maturity Italian paper rose 3bp to 1.44 percent as investors digested Mr Draghi’s comments on negative interest rates.

The move of ECB came as a surprise to many analysts.

With these announced measures, the ECB wants to get money into the financial system by discouraging banks from holding on to deposits and instead lend out money as cheaply as possible to businesses and households.

The ECB is keen to stimulate the eurozone, against the backdrop of an imperilled global economy. Data in February showed Greece  – one of the eurozone members worst hit by the economic crisis – fell back into recession and that prices have not risen since July of last year. Data shows also that Italy slowed to near stagnation and that some economists are also worried about deflation in Spain.

Germany, the eurozone’s largest economy, grew by just 0.3%. On top of weak growth, inflation is negative – which can discourage businesses and consumers from spending. Headline inflation dropped to -0.2% in February, down from 0.3% in January.

The 19 countries in the eurozone have had a negative interest rate for deposits since June 2014. But this is the first time the ECB has set the rate at which it lends to banks to zero.

Since June 2014, the ECB has been trying to discourage banks from holding on to savings by cutting the deposit rate to -0.1%. Since then it has cut it to -0.2%, then to -0.3% last December and the rate has now been cut to -o.4%.

The questions most investors would be asking themselves is:

Ultra-low interest rates create difficulties for commercial banks because it makes it harder for financial institutions to lend profitably. The ECB, though, is trying to mitigate the impact by allowing the rate at which banks borrow over the long term to drop into negative territory, too.

By increasing the amount of quantitative easing and the type of bonds it is prepared to buy up, the ECB is also signalling it wants to get more money pumped around the eurozone financial system.

Based on the above, we believe that there is no guarantee that its latest ‘ECB bazooka’ will be any more effective than previous ones in securing the strong and sustained growth required to eliminate the threat of deflation in the currency union and allow the peripheral countries to tackle their debt problems. The ECB has belatedly delivered, but it can’t work miracles.

Not all ECB policymakers backed the package, which also included cuts to all of the central bank’s benchmark interest rates. The vote in favour was 19 to two, with the dissenting votes cast by the head of the Dutch central bank, Klaas Knot, and Sabine Lautenschläger, the German member of the ECB governing council.

Last but not lease a critical question most investors would be asking themselves with negative interest rates in Japan and the EU, which big economic power will be next?

Until next time

Yours sincerely,

Suriname Times foto

Eric Panneflek

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