How Mario Draghi Brought Out The Big Guns In Europe

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This morning Mario Draghi and the European Central Bank (ECB) took a very bold move, they pushed interest rates into negative territory.

This is part of an aggressive approach to combat weak growth and low inflation that are plaguing the eurozone.

Draghi had highlighted three steps to counter this weakness at an ECB forum last month; lower interest rates, targeted lending to non-financial corporates and finally a broad-based asset purchase program. Today we got two of three of these steps.

Here are the key takeaways and what they mean:

Negative rates

The deposit rate was lowered to -0.1%, from 0%, effective June 11.

The idea is that if banks aren't being rewarded for parking their reserves at the central bank, then they will be more likely to lend it to households and businesses. But George Magnus makes an interesting point in a Financial Times column, suggesting that this move won't be that powerful. 

"European banks’ deposits at the ECB have fallen close to zero in the past several months, and their reserve holdings at the ECB, to which negative rates will also apply, have also diminished significantly," he writes. "The negative interest rate, therefore, is unlikely to have a significant effect on banks’ behavior."

Draghi added that ultimately the decision to lower rates for households is the decision of banks, not the ECB. "There is a deep misunderstanding here. The rates we've changed are for the banks, not for the people," Draghi said. It's wrong to think the ECB wants "to expropriate savers. ...The concerns of savers should be taken very seriously."

Targeted LTROs

The ECB unveiled targeted LTROs (Long Term Refinancing Operation), which is about €400 billion and that will mature in September 2018, or in about 4 years.

Basically these are subsidized loans in targeted areas, when you look at it from the supply side, because banks are going to the ECB to get liquidity which they might not be able to get elsehwere, Vistesen told Business Insider in a phone interview, it's "passive balance sheet expansion."

But the key thing is that their is impaired demand, since the non-financial corporate sector in peripheral economies aren't doing as well, he said. 

The TLTROs are basically intended to boost lending to the non-financial private sector, and this excludes loans for home purchases. 

"The cost obviously, it is very low, the term maturity is four years, and the termination that this money not be spent on sovereigns and on sectors that are already experienced or have just come out of a bubbly situation, that's what in it," explained Draghi during the press conference.

"The set-up is taken straight out of the BoE’s playbook as it does not apply to house purchases—providing a nod to the BoE’s recent criticism of the Help-to-Buy program—and is instead conditioned specifically to loans for the non-financial corporate sector," Claus Vistesen at Pantheon Macroeconomics wrote in an email.

The end of SMP sterilization

Under the SMP program the ECB would buy securities on the secondary market (from banks and against market prices) but sterilize its purchases by removing an equivalent amount of liquidity from the system.

The ECB moved to end its securities market program (SMP) sterilization, which should add €175 billion to the ECB’s balance sheet. This sends the message that the "the central bank is now ready to consider outright balance sheet expansion later this year," writes Vistesen.

Outright Purchases of Asset Backed Securities (ABS)

The Governing Council is working to "intensify preparatory work related to outright purchases in the ABS market to enhance the functioning of the monetary policy transmission mechanism, given the role of this market in facilitating new credit flows to the economy."

The ABS will essentially see the ECB buy bundled packages of small and medium enterprise loans. Vistesen argues that the market "cannot currently accommodate the flow from an aggressive purchasing programme in this sector."

No big bazooka just yet

The ECB did not announce full quantitative easing — purchases of government bonds as undertaken by the Fed — but has left that option open.

"The details of the announcement indicate that QE is still a thorny issue, and a step that the central bank would prefer to avoid for as long as possible," Vistesen.

The ECB has thrown everything but the kitchen sink at a eurozone economy," Nicholas Spiro, managing director, at Spiro Sovereign Strategy wrote in an email to clients. "...The reality is that markets continue to expect far too much from the ECB and are letting the Eurozone's politicians, particularly those in France, off the hook. "

But the last word on this comes from Draghi. "Are we finished? The answer is no," he said.



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