European Central Bank lowers all key rates, accelerates asset purchases, makes investment-grade corporate bonds eligible for the “QE” programme and introduces new Targeted Longer-Term Operations (TLROs).
TLROs are favourable to European banks, which should help reduce concerns over systemic risk in the euro zone. We retain a positive view on risky assets.
The governing council of the European Central Bank (ECB) has loosened monetary policy further. On 10 March, it announced a cut in the deposit rate from -0.3 to -0.4 percent, as expected by most economists. What was surprising, though, was the lowering of the other key rates: both the rate on the main refinancing operations (MRO or repo rate) and the rate of the marginal lending facility fell by 5 basis points (bps) to 0.0 percent and 0.25 percent, respectively. The asset-purchasing programme was expanded by an additional 20 billion euros to 80 billion euros per month, exceeding market expectations of a 10-billion-euro increase. We estimate these measures to propel the ECB’s balance sheet to 3,820 billion euros at the end of March 2017, equivalent to about 34 percent of the projected gross domestic product (see chart).
Chart: ECB’s balance sheet will increase even faster – repo rate to drop even lower
Source: ECB, Thomson Reuters Datastream, Vontobel Asset Management
The president of the ECB, Mario Draghi, said that the new extended asset purchases starting in April would also cover non-bank investment-grade corporate bonds. In addition, the ECB will be able to hold a share of up to 50 percent of any issuer or issue of bonds from eligible international organisations and multilateral development banks instead of only 33 percent as before. These two expansions of its programme range should provide the ECB with enough ammunition for increased asset purchases. Moreover, the ECB will in June launch new so-called Targeted Longer Term Refinancing Operations (“TLTRO II”), a programme designed to stimulate bank lending to household and firms. The TLTRO interest rate is basically the actual repo rate. However, banks with higher net lending than the benchmark can take advantage of a rate as low as the deposit rate (-0.4 percent). Both additional measures, corporate bonds and TLTRO II, came as a surprise to most observers. Finally, the ECB indicated that the low interest-rate environment would last for an extended period – longer than the ECB’s asset-purchasing programme.
Draghi takes European banks’ concerns seriously
Mario Draghi went to great lengths to alleviate concerns over the health of the euro-zone banking sector. To us, this was the most striking point during the media conference that followed the ECB decision. In particular, Draghi mentioned a press release in which the European Commission urged banking supervisors to adjust their ruling on the so-called maximum distributable amount (MDA) – the money banks can, among other purposes, use for coupons on its contingent convertible bonds (“cocos”). This is significant because of recent worries that banks would have to skip such payments if their profits or capital requirements do not reach a certain level. In our opinion, the new TLTRO programme and the supportive communication will help reduce fears of system risk tied to European banks and further support lending conditions for firms and households in the euro zone.
ECB’s commitment is intact
From our perspective, the ECB’s actions indicate its commitment to mitigate the risk tied to low inflation and sluggish economic growth. The policy decisions were in line or ahead of expectations. However, markets swings during and after the press conference also reflected market participants’ potential loss of confidence in the “unlimited power” of central banks to prop up financial markets and whole economies. That being said, the new “TLTRO II” programme may well calm fears of systemic risk affecting the euro-zone banking sector: it allows banks to lend long-term liquidity at very attractive conditions, which should help offset the drag from negative ECB deposit rates. Another positive is the willingness to provide clarification on MDA calculation, an issue that has recently put significant pressure on bank shares and debt instruments. Finally, the ECB president stated that the “weapon” of negative interest rates is now used up, which should come as a relief to banks. Overall, we believe that the ECB’s actions will contribute to strengthen confidence in the banking system of the euro zone.
Market Update by Vontobel