In specific terms he sees the ECB taking the following action:
Despite some of these moves being unprecedented Raoul forecasts that the impact could be limited. This is for three reasons. First, much of it has been priced in as the moves have long been expected. Second, the impacts of a negative deposit rate and targeted LTRO are far from certain. Finally because it does not address the key problem, as he notes:
It could also decide to end the sterilisation of the Securities Market Programme purchases, creating a liquidity injection of €164.5bn and loosen collateral rules further. The ECB will likely keep asset purchases (both of private assets and government debt) in reserve but will likely reiterate that such action remains possible as part of a broader dovish statement from Draghi.
- Cut the main interest rate to 0.15% (from 0.25% now).
- Cut the deposit rate to -0.1% (from 0% now). This will be an unprecedented move.
- Announce a new Long Term Repurchase Operation (LTRO) focused on boosting lending to small and medium sized businesses. The term of the LTRO will be between 3 and 5 years, rates will be reduced if banks provide evidence of a pick-up in lending (see below for a useful Nomura graphic on this).
As the chart below shows (courtesy of SocGen) the biggest problem facing the eurozone financial system at the moment remains the discrepancy in lending rates to businesses in different economies. The knock-on impact of this is limiting credit in countries where the economy needs it and where it is needed to help drive inflation and growth.
It’s not clear that the rate cut, negative deposit rate or the LTRO will help close this gap. Fundamentally this gap is driven by a few factors which these issues do not address:
- Banks continue to deleverage and overhaul their balance sheets. The ECB’s Asset Quality Review and the bank stress tests are in the process of trying to put banks on a surer footing but until they are all done and dusted this process will weigh on banks actions.
- Cross border lending system in the eurozone remains fractured. Banks and investors on the whole are still not willing to lend and invest heavily in the peripheral economies. This stops the excess liquidity in the stronger countries filtering in the weaker ones. While negative rates will seek to encourage such movement by pushing a search for yield it is unlikely to override concerns over risk and the desire for safe assets.
- As recent ECB bank lending surveys highlight the problem is not just on the supply side but also the demand side. The economic overhaul, reform and rebalancing on many of the eurozone economies (both in the core and periphery) is an on-going process. Not only does this itself limit demand but it highlights that lending must be to new sectors and new drivers of economic growth rather than helping to simply prop up older sectors (here I am thinking for example in Spain of lending to new services rather than to the old real estate and construction sector).