The main policy interest rate has been lowered from 0.15% to 0.05%, while the deposit rate, previously lowered to -0.1%, has also been lowered to -0.2%. In addition, ECB President Mario Draghi announced that the central bank will start to purchase private assets - in particular, asset backed securities (ABS - mainly securitised debt). More details of purchases including size and scope will be revealed at next month’s ECB press conference. At the meeting in June, the ECB had previously announced that it would investigate the feasibility of buying ABS, and so the follow up and announcement of future purchases are not a surprise.
Draghi cited a combination of the worsening of the inflation outlook, the recent downward movements in all indicators of inflation expectations, poor growth in bank lending, and the weak growth data published over the last month as the key reasons for adding further stimulus.
So far, risk assets have responded positively to the news, with European bourses trading higher, government bonds seeing lower yields, and the euro depreciating.
In our view, the cut in interest rates is totally irrelevant. Due to the glut of liquidity in money markets, short-term interest rates have been below the ECB’s main financing rate for some time – meaning that the latest cut will have near zero impact. The purchase of ABS is designed to transfer the risk of packaged loans from banks to the ECB, which in theory should free up capital for those banks to increase lending to households and corporates. Of course, there is no guarantee those banks will choose to lend more, especially as some are under pressure from a regulatory position to boost their core capital holdings. Moreover, according to JP Morgan, the ABS market in Europe is very small. Europe’s ABS market is worth approximately €1.2 trillion, but excluding non-Eurozone issue, the market is just €885 billion. However, as most of the existing stock of ABS is being used as collateral to access various ECB repo operations, the actual available stock in the secondary market is just €251bn – barely worth 2.6% of GDP. Compared to the size of the Fed’s balance sheet of $4.4 trillion (approximately €5.7 trillion), the ECB’s ABS purchases are unlikely to be large enough to make any real impact on the real economy. From the view of market participants, the ECB is also likely to crowd out long-term buyers of the asset class, which may irreversibly hurt the health of the market in the long-term.
The limitations of the ABS market have naturally pushed investors to conclude that the ECB will eventually be forced to buy other assets, but in particular, sovereign debt in the same way the Fed and Bank of England were. For now, this is not on the ECB’s agenda, and if the ECB’s staff projections are right in forecasting a recovery in growth and inflation for next year, the ECB may never have to embark down that controversial path. It is worth mentioning that Draghi revealed that while some members of the governing council wanted more stimulus than was announced, a minority voted against the action that was eventually settled on. This suggests that there is still lots of resistance to QE, but also that other more aggressive options are available to use. Given the reaction in markets, investors are clearly betting on even more stimulus soon.