ECB finally comes up with bolder action

The ECB overshot already existing high market expectations by taking even bolder action at its latest monetary policy meeting on Thursday. Not only has it announced an asset purchasing programme of asset-backed securities (ABS) and covered bonds to be started in October, but has also taken off its last scope of conventional monetary policy by cutting the main refinancing rate to 0.05% down from 0.15%. Similarly, the lower and upper bands of the interest-rate corridor have been lowered by 10 basis points.

TLTRO

Hence, the deposit facility and the marginal lending facility now stand at -0.2% and 0.3%, respectively. ECB president Mario Draghi outlined at the press conference after the governing council meeting that headline rates have been cut in order to spur issuance of the targeted long-term refinancing operations (TLTRO). In fact, as the ECB has exhausted the zero bound of the main refinancing rate banks will not refrain from TLTROs in expectations of even lower rates going for-ward.

Although we have not foreseen that the ECB would act at this month policy meeting, it is certainly justified and should have come earlier this year. Soft and hard data has been signalling that economic expansion in the eurozone has been slowing for quite a while now, suggesting that inflationary pressure stemming from wage growth is not in sight. Admittedly, an ABS purchasing programme has been a bold step for the usually rather conservative ECB. It will revive speculations over real QE such as outright asset purchases of sovereign bonds, which directly inject liquidity into the markets rather than to enforce credit and risk-taking. As a result, this creates room for disappointment in the financial markets since this is still hardly manageable within the given legal framework of the ECB.

Risks

While the real effect of the announced programmes is complex to measure and will only be mirrored in hard data with a significant time lag, we appreciate that the ECB has moved towards a more aggressive monetary policy stance. In fact, the cost of doing nothing to combat rising deflationary risk and the persistent slack in the economy outweighs the risk of possible negative side-effects, namely an overheating in asset prices. The latest developments offer downside towards our 3-month EUR/USD forecast; however, turning to the longer term picture, we stick to our opinion that we should see a stronger euro given the rising current account surplus and less negative real interest rates of the eurozone compared with the US.

With a cut in headline rates and the announcement of ABS and covered bonds purchases, the ECB finally addresses growing deflationary risk in the eurozone; however, it will take time for the measures to unfold.

Stephanie Lindeck, Economic Research, Julius Baer