The ECB exceeds expectations, aiming for stimulus to the real economy

 

What was expected by market participants?

We were convinced that further easing by the ECB at its March meeting highly likely, as a result of lower inflation, sticky bank lending, and fragile financial conditions. Ahead of the meeting, market participants considered the following tools as possible action paths:

 

•           Rate cuts: focus was on the deposit rate, with near-universal expectation of a 10bp cut and small number of forecasters considering even bigger cuts as possible.

•           QE expansion:

o          by size - €20bn increase in monthly purchases was the base case.

o          by type - possibility of IG corporate bonds being included in the asset purchase universe was also discussed.

•           Credit easing  through the banking system: more LTROs were considered as likely. The ability of banks to borrow at negative rates in order to lend to the real economy was considered a remote possibility.

What has been announced

•           Cut of the deposit rate to even more negative territory from -0.30% to -0.40%. Cut of the refi rate from 0.05% to 0%. Matches expectations.

•           Expanding the size of the QE program from €60bn/month to €80bn/month. Matches high end of expectations.

•           Expanding the composition of the QE program to include Investment Grade bonds issued by non-bank corporations. Exceeds expectations.

•           Proving LTROs with long maturities (4-year) at ultra-low rates (starting at refi rate and falling as low as depo rate, if lending gets expanded beyond a certain benchmark). Exceeds expectations.

Conclusions

•           The ECB seeks to provide stimulus to the real economy by firing all its guns:  interest rates, bank lending, direct asset purchases.

•           We find the bank lending channel particularly important. Banks are a critical part of the European economy and lending constraints could pose a large threat to its recovery. The ECB has taken action to address such concerns, by bringing down bank funding costs and potentially even paying banks to lend to the real economy.

•           The ECB appears confident on the effectiveness of its toolkit. President Draghi showed no concerns about the overall profitability of the banking system despite negative rates, expressed expectations for a large TLTRO2 take-up, and saw forward guidance as a powerful tool still exerting its influence across the entire yield curve.

•           By stating that the scope for further rate cuts is limited and choosing to focus on other channels, such as bank lending and corporate bonds, Draghi has eased the pressure on other central banks to match the ECB’s moves. This is likely to keep the SNB in wait and see mode for the time being.

source Lombard Odier