- A charged package: further negative rates, strengthened forward guidance, more QE, two-tier system for reserve remuneration, easing TLTRO conditions.
- The door remains open for further easing if needed, but the ECB makes a strong call for more active fiscal policy.
- Inflation projections have been revised down over the forecast horizon. GDP growth also, but less.
The big question mark before the meeting was to see the size of the pre-announced packaged of measures, in particular if it was going to include further QE or not -given the doubts expressed by several Governing Council members prior to the meeting.
And the central bank came in line with what we were expecting announcing a strong package of further accommodative measures. By unanimity (for some measures) or with broad consensus (for others), the ECB enhanced the forward guidance on rates, cut the depo rate by 10bps, announced a two-tier system for bank reserves and a new open-ended asset purchase program (APP) and sweetened TLTRO-III conditions. Only the last one came at a relative surprise.
At the same time, Mr. Draghi gave a strong message on the need to activate fiscal policy. At every other answer during the Q&A session he introduced the issue, and he took care to point out that the ECB has shifted significantly its call for more active fiscal policy for countries with space do it (i.e. mostly Germany) while others should let automatic stabilizers do their work.
The ECB pointed out three elements which had driven today’s decision: a protracted slowdown, the persistence of downside risks in global trade and the downward revision in inflation projections. Moreover, the central bank reaffirmed its readiness to adjust its instruments further if needed (as risks remain tilted to the downside). Specifically, the ECB mentions that rates are expected to remain at present or lower levels until inflation convincingly approaches its target (more on this later).
More in detail, the package of monetary policy measures includes:
- As expected, the ECB lowered the deposit facility rate. The cut was by 10bps to -0.50%, while keeping unchanged the refi and marginal facility rates at 0% and 0.25% respectively. Additionally, the central bank left the door open to further rate cuts by noting that key ECB interest rates will “remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon.” The ECB also strengthened its forward guidance dropping the calendar-based forward guidance and replacing it with inflationlinked guidance.
- As widely expected, the ECB will introduce a two-tier system for reserve remuneration whereby part of banks’ holdings of excess liquidity will be exempted from the negative deposit facility rate, trying to mitigate their adverse impact to banks’ profitability. A multiple of six times minimum reserve system will be exempted, along the lines of the Swiss model, which is more egalitarian among Eurozone countries than other alternative systems. Although such a multiple factor is lower more conservative than expected, it may be adjusted according to the ECB “such that short-term money market rates are not unduly influenced”. With this system, and this multiplier, we estimate that around 40% of excess reserves of Eurozone banks will be exempted from a negative depo rate.
- The ECB will restart the Assets Purchase Programme. The new QE package amounts to a (relatively low) 20 billion EUR per month, starting in November, and is open ended (as opposed to the previous program which had a time limit). This implies that, unless current 33% issuer limits are changed, QE will continue for only several months unless the ECB widens the limits of purchases (or moves to other types of assets). In this regard, Mr Draghi clarified that the Governing Council did not discuss these, as there is still margin to continue with the current ones.
- In a not much anticipated decision, the ECB also eased TLTRO-III conditions, with a lower rate for banks exceeding the net lending benchmark, and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation (the 10bp surcharge has been suppressed). Additionally, the maturity of the operations will be extended from two to three years, with a repayment option after two years.
- As expected, the ECB strengthened alto its forward guidance by:
- Switching from calendar-based rate hikes to increases contingent on inflation measures.
- Making QE open-ended, that will be phased out shortly before the next rate hike (which suggests a long programme if needed but also flexibility to hike rates).
- Strengthening the language on inflation convergence to target: convergence has to be "robust" and reflected in underlying inflation (which is a novelty for the y for the ECB, which has always rejected to switch the emphasis from headline to core inflation).
The Staff macroeconomic projections have been revised down over the forecast horizon, as a result of the persistence of the weaker economic momentum in the area driven by the worsening of global trade and manufacturing sector. GDP growth is now projected at 1.1% (1.2% in June’s forecasts) in 2019, 1.2% (1.4%) in 2020 and 1.4% (1.4%) in 2021. Despite the resilience of domestic demand and tightening labour market conditions, Mr Draghi stressed that the pass-through of higher labour costs to inflation is taking longer than previously expected. This, along with lower oil prices forecasts, lead also to a significant downward revision for inflation in 2020 (-0.4pp to 1% for headline and -0.2pp to 1.2% for core inflation) and a more gradual increase in 2021 (-0.1pp for both headline and core figures to 1.5%). Draghi stressed that the updated forecasts continue to reflect a favourable scenario (no hard Brexit, no trade war escalation) and risks are tilted to the downside (trade war, geopolitical and vulnerabilities in emerging markets), adding that the probability of recession is still small but it is gone up.
All in all, Mr. Draghi has not disappointed on the expectations generated by the ECB itself. The message from the ECB has been dovish enough, as the ECB reacts to the increasing and prolonged uncertainty with a combination of non-standard measures and opening the door for further easing. But the question remains open if the actual conditions and risks of the Eurozone economy call for such a package. In addition, the marginal effect of further monetary measures is rapidly decreasing, as seems to be recognized by the ECB itself with such a strong call for fiscal policy.
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