European Central Bank: New Policy Measures

The European Central Bank was centre stage last week with their latest monetary policy announcement. It was only last night that I got a chance to watch his full press conference, after the Ireland match. I can say both were on par in terms of entertainment, bar some McGeady magic, but to me it also looks like Mario Draghi pulled a masterstroke in the expectations game with financial markets. Aware that he was under significant pressure to do more, against a backdrop of weak inflation and growth dynamics, Draghi surprised and appeased markets without actually doing that much.

Interest Rate Cuts: “Now we are at the Lower Bound”

The ECB made a surprise cut of 10 basis points to all three interest rates, with the rates on their main refinancing operations, the marginal lending facility rate and the deposit facility rates now standing at 0.05%, 0.30% and -0.20% respectively. (As a reminder, the negative deposit rate applies to cash held with the ECB in excess of the minimum reserve requirements, in essence a levy on banks to motivate additional lending). As Draghi said, interest rates were already “for all practical purposes at the lower bound, but technical adjustments could be possible”. These cuts are just technical adjustments, and it seems unreasonable to believe that it will have any marginal impact on easing credit conditions in the real economy.

Outright Purchases of Asset Backed Securities & Covered Bonds

The Eurosystem will purchase a broad portfolio of “simple and transparent asset-backed securities (ABSs)” with underlying claims linked to non-financial private sector debt under a new ABS purchase programme. They will also purchase “euro-denominated covered bonds issued by MFIs domiciled in the euro area” under a new covered bond purchase programme.

Forward Guidance & “Additional Unconventional Instruments”

As well as strengthening their commitment to forward guidance, i.e. keeping rates lower for longer, the ECB once again reaffirmed that the “Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate”.  The ECB are moving closer to the limits of their mandate, with uncertainty still hanging over whether they can actually purchase government bonds within the current mandate. Still, his comments alone are enough to convince markets that the ECB could yet embark on a large scale government bond buying programme, akin to the other major central banks.

Conclusion: The latest package of measures was received well by financial markets, the typical pavlovian response to monetary stimulus that we have observed over the last five years. However, whether it will be enough to boost the ailing Eurozone economy remains to be seen. Overall, while the ECB is making every effort to support the recovery, monetary policy will be ineffective without structural reform while fiscal policy will also have to play its part. This was the key message from Mario Draghi’s press conference, one that will most likely be ignored!