The ECB’s latest policy package announced three weeks ago aimed high, with multiple measures seeking to ease financial conditions, boost bank lending, push inflation higher and support the euro area’s feeble economic recovery. But has it had any meaningful effect so far?
In financial markets at least, the effects of the ECB’s new measures are easy to gauge.
- In bond and money markets, the rate cuts have pushed down short-term yields. German bill yields are back in negative territory. And one-week EONIA is firmly in low single digits, about 10bps below its pre-meeting level.
- The ECB’s signal that rates are likely to be kept exceptionally low for an extended period – a message that, as Draghi noted last week, was reinforced by the initiatives to boost liquidity – has prompted larger declines in yields and spreads further along the curve.
- But there has been no impact on market measures of inflation expectations. And the euro has remained stubbornly firm, albeit down from the multi-year highs against the dollar reached at the start of May.
In the real world, the ECB has less to show for its efforts. It would, of course, be absurd to expect to see signs already of an impact on growth and inflation. But the deterioration in many economic confidence indicators in June suggests that firms and households are not that impressed. And while June data on lending volumes and interest rates will not be available for several weeks, it is far too soon to have expected banks to have changed behaviour. Certainly, excess liquidity in the banking system has failed to decline, remaining well in excess of €100bn. And while the latest tender on 20 June resulted in an LTRO repayment of €12.6bn, the highest in three months, this was not entirely out of line with the recent average. That is a little surprising given that the negative deposit rate means that banks are paying a price for hoarding funds. But in most instances, banks flush with excess liquidity seem unlikely to be the same ones as those with large LTRO liabilities.
The ECB would, of course, prefer hoarded funds to be lent. The conclusion of the ECB’s Asset Quality Review and Stress Tests might encourage lending in the interbank market by easing concerns on credit risk. But the full results are not due until October. And in the absence of a step change in the pace of economic recovery, a sudden splurge of lending to non-financial firms and households seems highly unlikely over the near-term too.
Indeed, the phased implementation over coming quarters of many of the ECB’s new initiatives means that the full impact of the June announcement is bound to be a long time coming. The first stage of the TLTROs will see two tenders conducted in September and December, offering fixed-rate loans maturing in September 2018 worth up to €400bn – roughly the amount by which lending to non-financial corporations has fallen since autumn 2011. These funds will provide all banks with an opportunity to refinance existing debt more cheaply. But with no clear incentives to raise lending offered, there seems little reason to believe that the first-round TLTROs will be any more successful in promoting new lending than the original LTROs at end-2011 and early 2012.
By contrast, the second-round TLTROs to be conducted quarterly between March 2015 and June 2016 seem better designed, with funds conditional on an increase in credit to the private sector (excluding mortgage lending) above a specified benchmark. Therefore, they should encourage some new lending. But while the total TLTRO funding could theoretically sum to close to €1trn, which would exceed the combined net take-up of the origingrABal LTROs, in practice we suspect total take-up will be some way short of that. Ample bank funding alone will not make other impediments to credit demand and supply magically disappear. For example, NPLs in Spain and Italy remain historically high, banks are struggling to improve profitability, bank capital is often little more than adequate, and ongoing balance sheet adjustment is still holding back credit demand. These headwinds are likely to persist for some time. And even when they eventually ease, the BoE’s and BoJ’s experience with similar conditional lending programmes suggests that the boost to credit from the TLTROs might prove underwhelming.
The final notable element of the ECB’s June package was its commitment to intensify preparations for ABS purchases. But the timeline for action is likely to be long, as the recent ECB/BoE joint discussion paper made clear. Given various regulatory and market hurdles, we would be surprised to see the emergence of a sufficiently liquid market in “simple and transparent” ABS (the ECB’s intended target) before 2016. So, given the potential impact on liquidity, ECB purchases of meaningful volume well before then might also seem unlikely.
Overall, therefore, apart from providing a modest benefit to some borrowers in money and capital markets, the ECB’s policy package has so far had little impact on what really matters: bank lending, economic growth and inflation. Over coming quarters the measures should at least be more widely felt. The TLTROs might help to arrest the downward trend in lending to non-financial firms. ABS purchases might help to reduce interest rates on loans at the periphery. And, as and when the Fed moves closer to tightening, the decoupling of euro- and dollar-denominated interest rates might weaken the euro, supporting exports and reversing the deflationary impact of past appreciation.
So the ECB’s actions have not altered our central scenario of very gradual economic recovery, continued low albeit rising inflation, and weak credit growth. But by the time the full effects of the measures have materialised, we would not exclude the possibility that underlying growth momentum and the inflation outlook have weakened. And that could well force the ECB’s hand to deliver the far more aggressive policy response – conventional QE – that the economic outlook arguably demanded all along.