With expectations running high and facing a plethora of policy options, the Governing Council of the European Central Bank crafted a package of measures at its meeting today that are aimed at delivering a monetary easing directly to the parts of the Eurozone’s real economy where it is needed the most.
After an initial fierce rally, financial markets have nevertheless given up all their gains and then some, on comments in the subsequent press conference by ECB President Mario Draghi. The ECB President indicated that while theoretically possible, deeper cuts into negative interest rate territory from here would be problematic at some level, and for all practical purposes, are probably off the table for now.
*** Lost in that communication “own goal” was a powerful message beyond a cursory mention to emphasize that the ECB can and will now instead focus on even further QE and expansion of its balance sheet if needed as its preferred policy option, even as it shies away from ever deeper cuts into negative rate territory. Indeed, today’s actions reflect that shift in policy mix already, delivering close to or ever so slightly under expectations on the rates side with a 10 basis points cut in the deposit rate, while over-delivering in a rather substantial way on the QE purchase program. ***
*** And when it comes to mitigating either the current or future adverse impact of negative rates on the banking system, markets had been focused on whether the ECB would adopt some sort of “tiering” system for charging negative deposit rates on bank reserves. But the ECB delivered instead what we believe to be a far more effective lifeline to Eurozone banks in announcing an aggressive second TLTRO lending facility, out to four years, pegged at zero interest rates for all banks, and potentially “charging” as low as the new deposit rate (-0.4%), if certain lending conditions are met by borrowers. In other words, banks will get money that is free, and could even be paid to borrow from the ECB. ***
Generous QE and Credit Support
On top of the extremely generous liquidity to Eurozone banks, the Governing Council decided of course to also substantially increase the size of its bond purchases by 20 billion Euros, from 60 to 80 billion Euros a month, above our expectations of a 10 to 15 billion Euro monthly bump, and to widen the composition of bond purchase in what Draghi characterized as “dramatic” fashion to include Investment Grade Corporate Bonds.
Many market participants had been looking for the ECB to perhaps also abandon the ECB “Key” metric by which it buys sovereign bonds in favor of a market-weighted index that would favor peripheral bonds, but as we suspected they did not do so. That said, we suspect the enormous positive impact of the outsize step-up in the QE program and the inclusion of corporate bond purchases will be more than enough to provide a significant degree of support to peripheral bond markets.
Less noticed was another small but significant tweak to a major self-imposed limit on the ECB QE program – a lifting of the 33% issuer and per issue limit on certain bond purchases to 50%.
While controversial, we had flagged the raising of limits beyond the 33% limit that would give the ECB a potential blocking ownership position in Collective Action Clause restructuring terms as an option that we understood could be considered instead of the change to the ECB Key purchases for certain highly rated bonds.
The Governing Council raised the limit and squared that controversy by applying the ceiling hike, at least for now, to bonds of eligible International Organizations and Multilateral Development Banks.
A Boost to Risk Assets, Eventually
As to markets, the ECB decision today has dampened near term expectations for further rate cuts, even as we suspect the TLTRO and QE commitments could eventually flatten the money market curve further out. And that, if anything, is for now neutral to positive for the Euro, as expectations for deeper rate cuts get taken out.
But an admittedly violent currency pop and near term disappointment sell-off in markets may not indicate a final failing mark for the ECB policy mix per se.
Indeed, in pushing its stimulus deeper into the banking system, credit markets, and peripheral countries, the ECB may have delivered a rather powerful – and desperately needed – boost to the real economy.
And despite the communications gaffe, when the dust settles, those measures and the prospect of a powerful bond purchase program to boot could, in the scheme of things, continue to put some wind into risk assets.