ECB: Throwing It All In

Published on March 7, 2019

At the European Central Bank’s last Governing Council meeting on January 24, ECB officials, alarmed over a faster and much deeper slowdown than they had been expecting, unanimously agreed to shift the assessment of risks to Eurozone growth to the downside. But they were still divided in two camps on when to take the series of actions they all knew would be needed to address the slowdown.

Today, they decided unanimously to move forward on every one of the tools available to them without haste: a slapped together new bank lending program; forward guidance pushing lift-off further back, and with it, a longer commitment to reinvestments of bonds maturing off their balance sheet.

** On lift-off, it has been very clear for some time that ECB officials, faced with a sudden slowdown in the economy, have had no problem with the markets having pushed expectations for lift-off from the negative 0.4% deposit rate well-past their calendar contingent “at least through the summer of 2019” guidance, and deep into 2020. While our expectation was for them to hold off on formalizing this guidance for lift-off on rates until closer to this summer, the Governing Council unanimously decided to lock 2019 in the bag and change guidance to “at least through the end of 2019.”

** Markets are already pricing lift-off for later than that, now September of 2020, according to latest guesstimates. But the ECB, in pushing out guidance on lift-off, is also pushing out guidance on its commitment to continuing reinvestments at a pace that will keep the ECB balance sheet from shrinking by at least an equal amount of time. The ECB had already established the relationship between the short rates and bond purchases in “chain-linking” reinvestments to lift-off, and ECB President Mario Draghi in his press conference went out of his way to reinforce this linkage, now formalized in the guidance assuring that reinvestments would keep flowing for an extended period of time after lift-off.

** As largely expected, the ECB announced that it would embark on a new round of TLTRO loans to the banking system, in quarterly tranches, but without any precision as yet on the “modalities” of this program beyond some broad parameters. With the intent of this new program ostensibly to keep liquidity for banks stable, and perhaps provide a little extra, but not crisis-level, juice to the banking sector to enhance the transmission mechanism of liquidity into the economy, the new program on its face will be less generous in lending for two, as opposed to four, years, and in pegging the lending rates to a variable refi rate as opposed to fixing them at current ultra-low rates.

** But even here, this “less generous” fixed rate may be in effect a moot point, as there is little expectation that the refi rate, currently set exactly at 0%, will go up anytime soon within that time window anyway. The ECB has done little to discourage the notion that the first step in lift-off, when the time does eventually come, will be to tweak the lower negative deposit rate up first, while presumably leaving other key rates, the refi and largely irrelevant marginal lending rate, unchanged.

** Most interesting to us, President Draghi confirmed there was indeed an active discussion at this meeting about the potential costs to the banking sector of leaving negative rates too low for too long, and with it a discussion of the pros and cons of tiering the currently universally applied negative deposit rate as other countries have done to ameliorate some of these pressures. While the ECB, and we, have phrased this discussion in the context of preparations for the current deposit rate levels remaining low well through 2020, we expect it will be only a matter of time before markets start wondering if this is also in preparation for a possible, even though as yet unlikely, deeper cut if needed in rates down the road.

Finally, on the broader assessment of the economy, one might be tempted to say that Draghi went out of his way, despite in effect throwing all the ECB’s readily available bullets at the economy in one shot, to underline the (dramatically lowered) baseline assumptions, while doing his best to reassure that the ECB does not expect a recession. But in truth, he made little effort to put any lipstick on the pig.

With the Federal Reserve for its part having engineered one of the most dramatic U-turns in its history from hike to hold between December and January, and now this from the ECB, one could question whether that aggressiveness, even as central bankers continue to insist there is nothing to fear, is a confidence building exercise for market and investor expectations.

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