ECB eased monetary policy further - supports June easing

The ECB has today eased monetary policy further in two ways:

• The ECB has cut all policy rates by 10bp , bringing the MRO to 0.05% and the deposit rate to - 0.20%.
  
• The ECB announced it will start buying simple Asset Backed Securities and a broad portfolio of covered bonds.
  

Overall , the measures should support the easing in June, when the ECB introduced a negative deposit rate and announced it would boost liquidity through TLTRO loans. This should follow as the lower negative deposit rate make s the hot potato ‘more hot’. At the same time , the ABS purchases will strengthen the effectiveness of the TLTROs as it removes loans from the banks’ balance sheet and hence increases the banks’ lending capacity to the real economy due to capital requirements.

So far , the size of the ABS and covered bonds purchases is unknown and , according to Mario Draghi , it is difficult to assess the size of the ABS program me as it will include new and existing ABS. But the ECB expects a sizeable impact o n the ECB balance sheet , which should also follow from the TLTROs. More details about the program me will be announced after the Governing Council meeting at the beginning of October. The purchases are due to start in October 2014.

Draghi stated that the E CB has now reached the lower bound on policy rates. The rate cut reduces the rate on the TLTRO loans and also removes the uncertainty about a lower rate in the future. Overall , banks should thus be less reluctant to take on the TLTROs. This could reflect t hat the information the ECB has about the take - up of the fi rst TLTRO in September is lower than what the ECB had hoped for.

The decisions taken by the ECB today w ere not unanimous, but according to Draghi a comfortable majority of the Governing Council was in favour of the program me . The ECB is still unanimous in using unconventional measures should it become necessary to further address risks on inflation. Related to that, the ECB did discuss broad - based QE and some members were in favour of doing more today .

The decisions taken by the ECB should underpin anchoring of inflation expectations. The ECB still sees expectations as anchored, but it has seen downside risks to inflation increasing and due to that it eased again. This low inflation was also reflected in the ECB staff projections , where the inflation projection for 2014 was lowered to 0.6% from 0.7%. The GDP growth forecast for 2014 - 15 was also lowered , while the projection for 2016 was revised up.

The market reaction to the rate cut was pronounced as it was not expected with any greater conviction. Hence, the Eonia forward curve declined some 6 - 8bp and is now pricing in negative Eonia O/N fixings well into 2016. As a consequence, the decline in core bond yields has been most pronounced in the 2 - 5y segment and periphery yields are declining across the curve , outpacing Bunds. It is noteworthy to see the steepening in the EUR swap curve from the long end as a sign of the market believing the ECB measures will lift growth and inflation expectations.