Today the European Central Bank (ECB) took rates into deeper negative territory by cutting the rate paid on its deposit facility to -0.20% (it also cut its other key policy rates). By doing so, the ECB is making financing conditions cheaper for banks, but it is also penalizing them for returning excess cash to the central bank. It wants that money circulating in the real economy to finance spending, create jobs, finance investment and boost economic growth.
ECB President Draghi’s speech at Jackson Hole was highly significant. Inflation and growth in the eurozone are currently heading towards zero. Unemployment is unacceptably high and longer term threats to social cohesion are likely to rise as a result. By referring to the unacceptable face of high unemployment and the destructive potential of persistent unemployment, Draghi acknowledged that the ECB does not operate in a political vacuum. Its independence is in the gift of the citizens of Europe. In this context, Draghi said that the ECB cannot stand idly by whilst the economy slowly implodes.
Additionally, Draghi acknowledged that fiscal austerity can be self-defeating. No growth and no inflation combined with high leverage is a toxic combination when it comes to the question of debt sustainability. In this context, he acknowledged that there can be some room for manoeuvre when it comes to accepting (and indeed accommodating) more fiscal spending. But he wasn’t handing it all to eurozone governments on a plate. In return for even more accommodative monetary policy, he asked for this spending to be channeled towards promoting supply side reforms, and raising skills levels and productivity. All these should ultimately boost the eurozone’s long term growth potential, which will be helpful in bringing leverage down, and monetary policy will be eased to soften the burden of adjustment.
Today the ECB also announced details of its Asset Backed Securities purchase programme which will start in October, be aimed at private sector assets, and which will have a sizeable impact on its balance sheet. Today’s measures were only an installment. We believe there will be more monetary easing to come in 2015. One question that is frequently asked is whether this means large scale asset purchases (LSAPs), also known as Quantitative Easing (QE) geared towards government bond purchases. Asking that question risks missing the big picture.
The big picture is that there will be more monetary easing still to come. We do not know for sure in what exact shape or form, but it will come. Indeed, with short end bond yields in the eurozone all close to zero, it is reasonable to ask what pushing them further down through government bond purchase QE may achieve. So, the big picture view should be to focus on the additional monetary policy easing that will be delivered by the ECB to raise demand, raise consumption and investment, and raise real growth potential in the eurozone. This is all credit risk positive for the eurozone and positive for eurozone risk assets.