ECB afterthoughts: Rate cuts but nothing more
Rates cut as expected
The much-anticipated European Central Bank’s meeting and the following press conference went without bigger surprises. The refinancing rate was decreased by 25 basis points to 0.50 percent, the marginal lending facility rate decreased by 50 basis points to 1 percent and the deposit facility rate unchanged at 0.00 percent (ECB). This was in line with expectations. The refinance rate cut has little effect on where it is needed, and should be seen more as signalinig at this point. The marginal lending facility rate has almost no effect at all as the amounts that are loaned through that channel are very small – though the aggressive cut can be interpreted as more signalling. See also the introductory statement and the previous statement from the April 4 meeting.
So what could the ECB be signalling? Mario Draghi threw the ball very forcefully back to Brussels and elected officials by calling for the banking union, continued fiscal balancing (not too much of austerity, but not too little, either) and bank recapitalisation. Draghi said that the ECB has a task force with the European Investment Bank on asset-backed securities or ABS. The real problem in Europe is not the high central bank rates, but high bank lending rates and low credit demand. The low interest rates of the ECB are not transmitting to the crisis countries and even in countries like Finland, the industry heads have recently been complaining about the high cost of credit. More thoughts on this at the end of this article.
Negative deposit rates – probably not
The deposit rate was left at zero and as the banking system has plenty of liquidity, this is the rate that is currently constraining lending. The banks prefer to have excess liquidity and park it at the central bank. During the press conference, Draghi said that technically the bank was prepared to cut the rate to negative territory, but also acknowledged that such an unprecedented move would have unwanted effects. It does not look probable that the ECB would actually go that way, but they kept the option open, nevertheless. See also Steen Jakobsen’s squawk.
In short, the ECB’s toolbox is currently almost empty, but it tries to scare the markets with talk on negative rates and ABS programmes. By repeating the acronyms LTRO and OMT at every press conference, Draghi establishes an “ECB put option” – this avoids disaster and tail risks, but does very little to help the real economy. The European leaders should soon decide if they will allow the ECB to perform like the other central banks are doing, but unfortunately such a decision will have to wait until someone either leaves the Euro club, or Germany’s elections are over. As I have said many times, Angela Merkel’s re-election campaign is the most expensive one in history.
EURUSD dropped, then went up after the interest rate announcement. It looks like we are back to range trading after a superficially convincing upside move, which would imply that there is more downside left.
More on the topic: loan packaging as a solution
The whole credit crisis started when the business of structuring and packaging of loans went from euphoria to catatonia. Both the demand and supply of asset-backed securities (ABS) died and has remained dead, just like Draghi stated during the press conference. This is one area where the ECB could be of assistance, by finding ways to help the packagers and investors to return to the game. There are plenty of ways, like easier collateral requirements, guarantees and smaller haircuts. While no one wants a return to the packaging madness seen before the crisis, the current situation, in which investors are hungry for yield and SMEs are not getting loans at acceptable rates, is not satisfactory either.
ABS-programmes are no panacea
The problem is such measures take time to design properly. Every country has its own issues, just like every sector has. The ECB does not want to pump up a sector and just recreate problems that have existed before. Supporting liquidity needs of banks and sovereigns is much easier than navigating the sea of corporate lending. Who rates the product? Who carries the risk? Will the added risk to the ECB actually provide the results that are wanted?
The ECB’s support for the ABS-market could be seen as a way to do quantitative easing within the central bank’s mandate. The Federal Reserve first started doing quantitative easing with government bonds, and later moved to ABS by starting purchases of mortgage loans. If the European ABS-programme would include mark-to-market policies and the risk would wholly belong to the banks, it would not be pure QE and debt mutualisation, although the ECB’s risks would increase slightly, in case the bank and/or the bank’s host country got intro trouble.
If the programme would take even more risk to the ECB (i.e. ECB buys them), it would constitute risk sharing and probable loss generation to the creditor countries. This would easily be perceived as a risk and wealth transfer, as well as face strong political resistance. Things would have to get lot worse before Germany would allow something like that to happen. See also Steen Jakobsen’s post related to SME lending.