ECB: trying the big bang

11 Mar 2016

  • After disappointing markets in December, the ECB tried a big-bang approach, but actually presents investors with a déjà-vu.
  • The ECB sees itself not running out of ammunition, but its focus is shifting from interest-rate policy to non-conventional tools.
  • Market scepticism of the effectiveness of monetary policy in general could diminish the impact of further ECB action.
  • We believe the latest measures are hardly the game changer some market participants had looked for. We prefer a cautious positioning in European assets for now.

At the news conference after January’s meeting of its policy-setting council, the ECB had indicated that more action was to come. But it had been (deliberately) vague about the instruments it could use and ECB council members had tried not to trigger overly big expectations over the last few weeks. At the same time, a debate raged among market participants about the (in)effectiveness of monetary policy in general and the possible harm that negative deposit rates could do to banks’ ability to lend.

The closer the March meeting of the ECB’s governing council came, the more published broker research lifted market expectations for bigger ECB steps. Anticipating the market response correctly became harder for the ECB. In this environment, it opted for a raft of measures:

  • Cutting its main refinancing (refi) rate by 5bp to 0%, accompanied by a 10bp cut in the deposit rate to minus 0.4%
  • Expanding the volume of monthly asset purchases by EUR 20 billion to EUR 80 billion until at least March 2017
  • Adding investment-grade euro corporate bonds to the list of eligible assets for purchase
  • Starting from June with a new TLTRO refinancing programme of loans with a maturity of four years

We believe the expanded asset buying volume and the inclusion of corporate credit were an attempt by the ECB to surprise markets positively to avoid another disappointment. After an initial euphoric reaction, with the euro losing roughly 1.5 cents against the USD, 10-year Bund yields down by 6bp to 0.16% and the EuroSTOXX equity index rising by roughly 3%, 10-year yields and the euro even surpassed the levels seen before the ECB news and equities gave up their gains.

In our view, the ECB’s possible contribution to real growth through these additional measures appears to be limited. The main impact will be in safeguarding growth in times of elevated uncertainty in the short term, improving financial conditions via its purchases of corporate bonds. In addition, for the medium term, the four-year TLTROs and the expanded QE programme should keep yields low for longer and help the central bank in its fight against the build-up of long-term deflation expectations.

At this spring meeting, the ECB delivered substantially more than in December, but it can be hardly satisfied by the ‘bang for the buck’ in terms of the market response either now or in December. This could be a painful lesson for the ECB.

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