ECB: Reloading the conventional measures

As expected, the ECB today cut its main refinancing rate by 25bps to a new record low of 0.5%. It also lowered the interest rate on its marginal lending facility by 50bps to 1.0%, narrowing the interest rate corridor around the main refinancing rate to 50bps from 75bps previously, leaving the deposit facility at 0%. While the narrowing of the corridor will further help to dampen volatility in the money market, in the current environment of excess liquidity, with money market rates closely tracking the deposit rate, the width of the corridor has arguably become less important for the ECB in steering short-term interest rates.

The ECB also announced that it will continue to conduct its main, special-term and longer-term refinancing operations as fixed rate tenders with full allotment for as long as necessary, and at least until the end of July 2014. In his press conference, Draghi remained very dovish, saying that the ECB will continue to monitor all information very closely and that it stands ready to act, while its monetary policy stance will remain accommodative for as long as needed. Draghi also said that there was a “very strong prevailing consensus for an interest rate cut of 25bps”, and that some Governing Council members had voted for a 50bps cut.

So, Draghi left the door open for another interest rate cut if the economic outlook darkens further. As we argued in our blog yesterday, the decision to cut rates mainly reflects that economic weakness has extended to core economies, where the monetary policy transmission still functions. And with Draghi hinting at more easing, he also no longer ruled out cutting the deposit rate into negative territory. In this case, Draghi said that the ECB would take measures to offset the unintended negative consequences, in particular with regard to the functioning of the money market, that such a move could imply.

But Draghi had much less to say on other possible measures, steering expectations of further policy action away from non-standard measures and towards further rate cuts. Indeed, although the ECB announced that it will start consultations with other European institutions with a view to help revive the asset-backed security (ABS) market, Draghi all but ruled out ECB purchases of such securities in the future. There was also no talk about easing further the collateral requirements at the ECB’s refinancing operations, with Draghi saying that with the continuation of the fixed rate full allotment tender procedure “a lack of funding can no longer be an excuse for a lack of lending”.

And so, in light of Draghi’s comments, we now expect the ECB to cut its key policy rates, including the deposit rate, by another 25bps, possibly as soon as June if economic conditions in the euro area’s core deteriorate further in coming weeks amid a weakening global backdrop. Euro area Q113 GDP data, due on 15 May, will provide further guidance as to whether a rate cut can be expected as soon as then. But with bank lending likely to remain subdued in coming months, and with downward pressure on prices remaining as domestic demand continues to contract, we think that another rate cut, if not in June, will come by August.

Tobias S. Blattner
Euro area Economist

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