- We expect the ECB to announce a package of measures at this week’s meeting, including…
- …15bp of policy rate cuts, taking the refi to 0.1% and the deposit rate to -0.15%…
- …as well as an ABS purchase programme and the extension of full allotment to 2016
ECB set to turn words into actions
This week’s ECB Governing Council meeting looks very likely to result in some monetary easing. At the May meeting, President Mario Draghi informed us in particularly candid language that the Governing Council was ‘comfortable with acting next time’ and that there was a consensus ‘not to resign to low inflation’. Last week, the ECB head continued to sound worried about the inflation outlook. He said that the Council needed ‘to be particularly watchful for the potential for a negative spiral to take hold between low inflation, falling inflation expectations and credit’. Mr Draghi emphasised that this could be a particular problem in stressed countries where ‘credit constraints are putting a brake on the recovery’. In terms of the response to the situation, the ECB President said that ‘the key issue is timing’ against the background of a rise in demand for credit and repair of bank balance sheets. This suggests that the central bank is willing to act pre-emptively to guard against the risks of a spiral. In short, there can be little doubt that the ECB will do something at this week’s meeting, the question is what exact policies it will adopt.
Policy rate cuts, with the deposit rate going negative
The ECB looks set to adopt a package of relatively modest measures. There are two inter-related issues that the central banks appears to want to tackle. The first is the tightening of financial conditions due to persistent euro strength. In May, Mr Draghi said that the euro is ‘a cause for serious concern’ against the background of ‘low inflation’. Although the currency is not a target, when it strengthens, it pushes down import prices and hence overall inflation, making it more difficult for the central bank to meet its price stability goal. Policy rate cuts are the policy tool that the ECB sees as being the most suitable to tackle euro strength. We expect a small cut (15bp) in both the refi and deposit rates. This would take the refi rate close to zero (0.1%) and the deposit rate into negative territory (-0.15%).
Credit easing also looks on the cards
The second issue that the central bank wants to tackle is tight private sector access to credit in parts of the eurozone. The ECB head emphasised this week that ‘credit constraints are putting a brake on the recovery’ in stressed countries. Indeed, although bank lending conditions appear to have stopped tightening for the eurozone as a whole, there are significant differences between member states. In general, bank lending conditions have deteriorated more sharply in a number of peripheral member states. Mr Draghi has put forward two potential policy solutions to this problem. The first is the introduction of a new LTRO for banks. In our view the problem with this option is that banks are currently repaying the previous 3-year LTROs, so the facility would need to be made more generous for a significant take up. This could be done by fixing the refi rate over the life of the loan, but even this might not make a huge difference. The ECB could extend full allotment (unlimited liquidity against appropriate collateral) in its main refi operations to 2016, but we do not expect a fresh LTRO.
ABS programme would make sense
The second option, is the introduction of an ABS purchase programme. The ABS market is currently in a slumber and could be an important mechanism for banks to finance new loans, as well as helping them remove some assets from their balance sheet. The template for such a credit easing programme is the ECB’s first covered bond programme, which focused on reviving a key market for bank funding. Overall, we think the ECB will likely launch an ABS purchase programme. Given the relatively small scale of that market, it would likely be of modest size (EUR 50 – 100 bn) and focus on high quality securities across a wide range of collateral.