Andrew Mulliner, Portfolio Manager on the Global Bonds Team, reflects on the European Central Bank’s decision to cut rates and bring back quantitative easing.
Expectations were high coming into the European Central Bank (ECB) meeting today in spite of press briefings by various hawks on the governing council rejecting the need for more quantitative easing (QE) in the eurozone. As has become Mario Draghi’s specialty, he managed to deliver a dovish surprise to markets in spite of clear reservations from some colleagues and, on paper, a relatively modest programme compared to what some had hoped for or expected. However, as is often the case with regards to monetary policy, the devil is in the details.
While much of the speech followed the script set out by ECB observers in the run up to today’s meeting, the big surprise came with the announcement that the revived QE programme should continue until just before the ECB next hikes rates as opposed to a much shorter time period that most had expected, of nine months to a year. Given the sclerotic condition of the eurozone economy, this promise to maintain QE until rates go up, is as good as a QE forever. The parallels to Japan are clear.
Another focus of attention for investors was the cut in interest rates and the programme of tiering the rate at which bank reserves are remunerated. The challenge for negative rates has been that, perhaps as far as the banks are concerned, the cure for low inflation (negative rates) may be worse than the disease. The measures put in place by the ECB are admittedly very technical and only time will tell if they are truly effective, however estimates are that the ECB has taken a measured approach. At the margins this will be beneficial to the banking community, however the drag on bank profitability remains.
The other actions were broadly as expected and potentially even on the stingier side of expectations. Deposit rates were cut by 10 basis points and the recently announced targeted longer-term refinancing operations (TLTROs) have been adjusted both in length and also in the form of incentives to banks to lend to the real economy in terms of potential interest cost. This brings them closely in line with the last TLTRO operations and makes them more generous with it. Finally, the forward guidance has shifted to focus on the inflation rate converging “robustly” to the target of close to, but below, 2%. This is compared to a date-based forward guidance which had gradually lost credibility as the ECB persistently missed its target. As ever, the ECB promised it could do more if required; however, we may wonder why doing the same thing over and over again should deliver different results.
The ECB has thrown the kitchen sink* at the eurozone economy once again, and we will have to see it if works. It was notable however that when asked about the unanimity of the governing council on these decisions, the only point of unanimous agreement was that fiscal policy needed to take the lead from monetary policy. Investors agree. The challenge is that, while we are seeing eurozone economies, including Germany, stepping in this direction, is there sufficient will to act as decisively as the ECB has been prepared to do?
With Christine Lagarde on her way in, Mario Draghi on his way out and a new commission president soon to be in place, the chess pieces are being positioned for a shift to fiscal. The question we ask is, will they be willing to do whatever it takes?
*'Throwing everything but the kitchen sink’ at a problem means using almost everything at one’s disposal. ‘Throwing the kitchen sink’ therefore means using all the options one has.