The measures include a cut in the headline rate of interest or the refinancing rate by reducing it from 0.25% to 0.15%. He also announced that the deposit rate will be reduced by 0.10% from zero to -0.10% and that the banks will be given access to €400bn of funds at a low rate of interest provided the funds are used to lend to small businesses. Finally, they will cease sterilising the new funds put into the market. The package is designed to increase liquidity and reduce the currency thereby increasing inflation and boost the economic expansion.
The cut in the refinancing rate to 0.15% was widely anticipated and is really not expected to make a huge amount of difference to economic growth. However, it will put savers under even more pressure in their hunt for good returns and push them towards more risky investments in order to get those returns particularly as Mario Draghi was not able to give them any encouragement for better returns with his prediction that rates will stay low for an extended period of time. His expectation for inflation, which is currently at 0.5%, is for it to be 0.7% this year followed by 1.1% in 2015 and 1.4% in 2016 and suggests that rates will be low for much of that time. The ECB’s target for inflation is 2.0% or under but such low levels will make it difficult for debts to be repaid and for liquidity to improve. What it will do is give businesses the confidence to seek funding for investment in the knowledge that their business plans will not be hit by the increase in their costs from interest payments. This will tend to reduce the returns they need to obtain in order to justify the investment in the first place.
By reducing the deposit rate that the ECB pays on any excess liquidity that banks leave with the Central Bank to -0.10% they hope to encourage them to take the funds back. They can then seek better returns by lending the money on to consumers and businesses at low interest rates. This may, however, entail the banks reducing their liquidity ratios and breeching the Regulators requirements at a time when they are also being subjected to very high fines from those same Regulators which also reduces their liquidity ratios. There will need to be some support from the Regulators for this policy to work. The amount involved is about €120bn which could have a large impact on liquidity ratios but which will only cost the banks €120m in interest charges. Many analysts doubt whether this announcement will have much effect.
The proposal to make €400bn available in what is to be known as targeted longer term refinancing operations or TLTRO may be more effective in improving liquidity as it gives the banks access to additional funds at a low rate of interest provided they are used for the purpose of supporting businesses. These funds will not be required to be repaid for two years and should give a boost to the economy although it has been likened to the Bank of England’s Funding for lending scheme which it is thought has had little impact on the lending conditions for businesses but which was increased with effect from the beginning of this year. The scheme will be launched in September 2014 with an additional tranche in December 2014. This will be followed by further tranches quarterly from March 2015 to June 2016. The total represents 7% of all outstanding loans to businesses and household excluding mortgages. They will all mature by September 2018 and interest will be paid at the time of maturity and will have been fixed when effected. These are very attractive loans for the banks and should make a difference to liquidity. In addition the withdrawal of sterilisation whereby the Central Bank buys back an equivalent amount of loans will give a further boost to liquidity.
In addition the Central Bank has announced that they are working hard on their preparatory plans to buy back asset-backed securities should that become necessary in the future. This is very close to a full scale quantitative easing programme and would only be considered and activated if inflation stays worryingly low.
Mario Draghi was keen to make the point that the ECB was not yet finished with policy actions that could be taken to combat slow growth and very low inflation. He was also keen to stress that it is necessary for countries to continue to put their own house in order and maintain the packages of reforms that they have all agreed upon during the crisis. He may not be happy to hear about the reforms announced by the Spanish government today to boost their economy and Mr Rajoy’s prospects of re-election next year!
The markets had been anticipating this announcement and there were few surprises in the package. One aim was to reduce the Euro against major currencies and thereby increase inflation and the Euro area’s competitiveness. Since May the Euro has fallen from $1.40 to $1.35 so the travel has been effective, however, the package will also lead to European assets becoming more attractive and could lead to a rising currency again as overseas buyers come in. The rise in the stock market that followed the announcement may be an indication of this trend.
Europe is a major global economic bloc and the relatively flat recovery has contributed to the low rate of global economic growth and the stagnation of equity markets this year. A boost to activity provided by this package could lead to better expectations for growth in profits and earnings which, in turn should justify the current valuations of markets and lead to higher forecast growth rates.
0 comments:
Post a Comment