Half a Bazooka Better than Nothing. The big day has finally come and gone for ECB’s Governor Mr. Mario Draghi to unveil his big bazooka to rescue the Eurozone economy. People are still scratching their heads, but the question is, did he deliver and what are the future prospects for the Eurozone economy and the Euro hold?
First the ECB cut the MRO and the deposit rate by 10bp and the marginal lending facility by 35bp. It is difficult to say with certainty at this stage what the net effect of these different measures will be on lending and the economy. Most view this move as mostly cosmetic, 10 bps is hardly enough to make anybody move for any reason.
Then the ECB cut its deposit rate for banks from zero to -0.1%. By setting a negative interest rate, the ECB wants to discourage banks from keeping larger reserves and promote a greater level of lending (and thus stimulate economic growth). In 2012, the Danish Central Bank introduced a -0.2 interest rate. It does not appear to have had any particular affect on either increasing lending or increasing withdrawal of cash from banks. Banks will either pass on the costs to their customers and/or use other means to store their funds safely via other measures in the private markets.
In addition, the ECB will conduct 2 TLTROs (Targeted LTROs) in September and December this year. Banks will be allowed to borrow 7% of their outstanding loans to the non-financial private sector excluding mortgages (according to the ECB, this amounts to €400bn). Banks can post any eligible collateral for these two operations. The interest rate of the TLTROs – the MRO rate at that point in time plus 10bp – will be fixed over the maturity of the operation. There will be four additional TLTROs between March 2015 and June 2016. This is probably the more significant part of the ECB efforts as it will allow banks to lend more, provided it makes sense to the businesses they loan to. But why would businesses expand, if all their customers are broke?
The big bazooka lays in storage, for the moment. As far as QE, the ECB merely said that it is “intensifying the preparatory work.” Mr. Draghi was asked several times during the ECB press conference about the likelihood of a large-scale asset purchase programme. As expected, Mr. Draghi did not rule out this possibility, saying that it was an option should the need arise. At a later point, this will likely happen. Though limited, this will play out over the summer in 2014. Mr. Draghi will use this point to try to jaw bone the Euro down, if it should creep higher.
In short, the June 2014 ECB meeting results, was a half Bazooka at best, though perhaps better than nothing. By the end of last week, the Euro was largely unchanged, though equities cheered the ECB efforts, and went to new highs, thinking that at least the pilot is not asleep at the wheel.
My view is that the measures taken by the ECB, are mere band-aids over the real structural issues that face the EU economy. A bit of a blip in excitement, but the longer term macro plays that have been in place will continue. The Eurozone economy will continue to stagnate, and drift lower in deflation. The Euro will regain some strength until they see even more ECB action, and other asset prices will rise as the new money, you guessed it, will pour into a new Eurozone equity asset bubble.
Unfortunately a lot people have yet to understand that, central banks can change prices of assets, but rarely can change actual economic realities on the ground over the long term.
Blue Point Trading, William Thompson