ECB View: Stimulus package not commensurate with economic shock – The ECB announced a relatively modest stimulus package yesterday. ECB President Lagarde called on fiscal policy instead of monetary policy to take the lead in responding to the economic shock from the virus. However she also signalled that further monetary stimulus was also a distinct possibility.
The measures announced by the ECB can be found here. Most noteworthy was an increase in net asset purchases and an easing of the TLTRO conditions. The ECB announced it will step up its net asset purchases by a cumulative EUR 120bn until the end of the year. This effectively means that net asset purchases will rise to around EUR 33bn per month from EUR 20bn currently, assuming that the new envelope kicks in from next month onwards. The ECB signalled that the increase will likely be focused on the private sector programmes.
Meanwhile, the ECB loosened the conditions on its TLTRO programme. The lending rate can be as low as 25bp below the deposit rate, so effectively a 25bp cut (for banks that maintain their levels of credit provision). This makes the facility very attractive for all banks relative to current market funding levels. The maximum amount that banks can borrow will be raised to 50% of eligible loans. This will allow banks to borrow around EUR 2300 bn net of existing TLTRO amounts outstanding (around EUR 600bn). Meanwhile, the ECB will also explore collateral easing measures.
The main surprise was that the ECB left its deposit rate unchanged at -0.5%. However, ECB President Lagarde stressed that this did not reflect that the central bank thought it had reached the reversal rate and its forward guidance continued to signal its willingness to cut this policy rate further.
The ECB announced new forecasts for the economic outlook but admitted that these were already completely out of date. However, ECB President Lagarde did give a qualitative assessment of the way the central bank currently saw the situation. She noted that ‘the spread of the coronavirus (COVID-19) has been a major shock to the growth prospects of the global and euro area economies’. This reflected that the shock ‘will slow down production as a result of disrupted supply chains and reduce domestic and foreign demand, especially through the adverse impact of the necessary containment measures. In addition, the heightened uncertainty negatively affects expenditure plans and their financing’. Ms. Lagarde noted that it was very likely that inflation would be lower than in the current projections, which currently already showed an undershoot of the goal in the medium term.
The ECB stepped up its calls for a more substantial response by governments. The press statement asserted that ‘an ambitious and coordinated fiscal policy response is required to support businesses and workers at risk’. President Lagarde noted that the extra fiscal measures at a eurozone level amounted to just 0.25% GDP so far, which the central bank clearly sees as being inadequate. The ECB also made it clear that it expected governments to take the lead in terms of the economic policy response to the crisis. However, the ECB also made it clear that it stood ready to ease policy further saying it would ‘monitor closely the implications of the spread of the coronavirus for the economy, for medium-term inflation and for the transmission of its monetary policy’ and that it stood ‘ready to adjust all of its instruments’.
We think that cutting the TLTRO rate and loosening the other programme conditions will be much more supportive of easier bank lending conditions than reducing the deposit rate. So the policy mix here makes sense. Having said that, the overall scale of the package, given that the economy is likely heading for recession, is modest. As such, we think that further policy easing will follow. We think that the pace of net asset purchases will likely be stepped up further, while further reductions in the TLTRO rate may also now follow to ease bank lending conditions. Furthermore, a reduction in the deposit rate is also not off the table.
Lagarde’s Duisenberg moment – ECB President Lagarde added to market disappointment about the scale of the package with a throw-away remark, which seemed to undermine around ten years of ECB crisis fighting. She said that the ECB was not here to ‘close bond spreads’. This remark undermined sentiment and not surprisingly led to rising bond spreads. She tried to make up for the remark later in a TV interview where she said that the ECB would deploy tools to mitigate ‘fragmentation risks’ and that its tools were completely available to Italy. In addition, she noted that the ECB could deviate from the capital key. (Nick Kounis & Aline Schuiling)