Global Daily – Officials give colour on ECB’s policy response

by: Nick Kounis

ECB View: TLTRO-III could be more generous than initial details suggest, QE-II an option – Over the last few days, a number of ECB Governing Council members spoke, providing some colour on the central bank’s policies going forward.

Olli Rehn, the Governor of the central bank of Finland, discussed the economic outlook and further details of the ECB’s TLTRO-III programme. The contender to be the next ECB President seemed to buy in to the idea that the slowdown is proving to be more serious. He noted that ‘compared to what many people expected at the end of last year, that this would be a short and temporary slowdown, it seems from many indicators that this is more durable’. However, he noted that ‘recession isn’t our baseline scenario’ as ‘while exports and to some extent investments are slowing down, domestic demand and services are holding up’.

Meanwhile, he gave more details on how the ECB would react to the slowdown. He signalled that the additional details of TLTRO-III would likely come in April or June. Crucially, he said that the modalities ‘should be close to TLTRO-II’. This suggests that the relevant loan benchmark would be loans ex-mortgages but the lending capacity would excluded existing TLTRO loans. Although this points to almost EUR 1 trillion of extra lending capacity, the extra amounts available for Italy (EUR 31bn) and Spain (EUR 43bn) would be limited according to our calculations. In addition, his remarks suggest that the cost of the loans could be lower than the refi rate and as low as -0.4% if banks meet lending benchmarks. That would make the TLTRO-III loans attractive relative to senior bonds and covered bonds for banks broadly. Of course, the key difference that remains (and we already know about) is the shorter maturity compared to TLTRO-II (two years versus four years), which makes the programme more of a transitional facility for banks to gradually reduce their borrowing from the ECB over the coming years, rather than a new stimulus measure.

Josef Makuch, the outgoing Governor of the central bank of Slovakia, struck a more upbeat tone on the economy. He said that recent data (apparently basing himself on the recent rise in the Ifo from low levels) supported the central bank’s optimism about a rebound in the second half of the year. He said that the probability of recession was ‘very low’. He also noted that the ECB could take more action to alleviate some of the adverse side effects of negative rates. He said that ‘if there is a need the ECB will pay attention and possibly take more measures at future meetings’. He was not specific on what measures, but one possibility is a tiered deposit rate system, where only proportion of excess reserves would be subject to the current negative level of the deposit rate.

Ardo Hansson, the Governor of the central bank of Estonia, struck a positive tone in interpreting recent data. He said that ‘the jury is still out on whether the short-term softness will spill over into the medium term’ and that ‘one can retain confidence that we’re going in the right direction’ given rising wage growth and falling unemployment. In discussing policy responses, he suggested that QE-II was an option, but that the hurdle was high saying it could be restarted in the event of a ‘major shock’. Still, given Mr Hansson is one of the most hawkish members of the Council, it suggests that QE is a possibility, while the hurdle for other officials might be lower.

Our base case is that the ECB will further push out its forward guidance on the period of unchanged policy rates and ongoing reinvestments. The modest trajectory for economic growth will not be sufficient for underlying inflationary pressures to build. We think that ECB forecasts for growth and inflation remain too high despite recent downgrades. Our base case is that ECB policy interest rates will remain on hold through to the end of 2020 and reinvestments will continue to end of 2021. However, the risks are to the downside and the probability is rising that the ECB will need to step up stimulus and restart QE. (Nick Kounis)