The Week In Hindsight, 06 June 2014
The ECB wrote history this week with multiple interest rate cuts, sending the deposit rate for financial institutions parking funds with it into negative territory; meaning that it will now cost lenders money to store excess funds at the central bank.
In addition to negative deposit rates, the ECB also cut the main refi (Min Bid) rate by 10 basis points to 0.15%, before announcing a package of additional stimulus measures. The most notable of these was a targeted long-term refinancing operation (TLTRO’s) which equates to 400 billion euros of cheap finance for lending, for a four year period at a fixed spread.
The TLTRO program is designed to provide cheap funds for banks to lend to non-financial organisations in the hope that borrowing and lending will increase across the continent, thus stimulating economic activity.
Thursday’s announcements followed a further drop in EU inflation to just 0.5%, against expectations for the Flash measure to remain at 0.7%. The measures unveiled by the bank boosted bonds and equities across the continent, while the euro posted a rapid retreat toward the lower end of the 1.3500 region against the US dollar.
Although the bank’s action steps have certainly served to boost activity across financial markets, it remains to be seen whether or not they can do the same for the real economy. This is because concerns exist that financial institutions within Europe will be reluctant to increase lending, despite the low cost, in the face of the pending asset quality review. In addition to this, uncertainties over whether or not there will be much demand for credit from the small and medium sized businesses of Europe are also a factor in doubts about the new measures.
Overall, we maintain a positive growth outlook for the continent as a whole over the months and quarters ahead given existing progress on the continent over the last 24 months. Nevertheless, we also feel that it is unlikely the ECB’s moves will translate into tangible benefits during the near term and for this reason; the likelihood that the governing council will be forced to take further action at a later date remains high.