Mario Draghi disappoints on unconventional measures

All in all, the ECB’s announcements on Thursday were below expectations. The 25bp rate cut had been widely expected. Despite Mario Draghi’s assertions, it is unlikely that this cut will have a decisive impact on economic recovery and on banks’ financing costs.

Thursday’s European monetary announcement only true surprise in terms of monetary policy was that the Governing Council appears to be seriously considering a negative deposit rate. However, as it is a two-edged tool, its impact on bank loans would be uncertain.

No clear guidance to unlock the credit crunch
A decision to buy asset-backed securities collateralised by SMEs loans would have been much more effective in improving loan conditions for corporations. The ECB’s attitude in this area continues to disappoint. The Governing Council still appears uncomfortable with the idea of taking on credit risk as Mario Draghi stressed that the ECB will not clean up banks’ balance sheets or finance governments. Nevertheless, the ECB seems to be resolved to revive the ABS market, notably ABS collateralised by SME loans. But the ECB is waiting for the European Investment Bank (EIB) to back such vehicles. It will therefore take several months more for an agreement to be reached.

Periphery stuck in recession
In the meantime, periphery SMEs will continue to struggle to find cheap financing. In all likelihood, economic activity will remain sluggish, in particular in the periphery, where the economies are unlikely to exit recession soon.

Sovereign bonds likely to be supported by bad economic news
These developments are likely to be favourable for the sovereign bond market. The handling of the Cyprus crisis has proved to the investor that taxpayers will be protected in future, as assistance programmes will be financed first through private creditors bail-in. This example has triggered a new regime that is favourable for sovereign bonds right across the board. Instead of adding stress, as was the case at the heart of the crisis, bad economic news now translates into lower bond yields on Bunds and also on periphery bonds. This regime  should not be interrupted by Thursday’s announcements.

The consequences are less clear-cut for stock markets. Recently, bad economic news was well received as it reinforced expectations of non-conventional ECB decisions. After Thursday’s announcements, though, equity investors could be disappointed, so this mechanism could be interrupted.

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A 25bp rate cut, as expected
As had been widely expected, the ECB decided to cut by 25bp its main refinancing rate (Refi). The marginal lending facility rate (the ceiling rate) was also cut but by 50bp. As a result, the corridor was reduced from 0.75% +/- 75bp to 0.5% +/- 50bp. The narrower corridor is expected to further reduce the volatility of the EONIA rate (the overnight interbank rate).

The ECB ready to cut deposit rate below zero
When questioned about the deposit rate, Mario Draghi hinted several times that the ECB was technically ready to cut the deposit rate below zero and, as such, it was ready to act if needed.

He went on to specify that there was a “very strong prevailing consensus” for a rate cut and a “prevailing consensus” for the 25bp reduction.

In response to a query about the effectiveness of a 25bp rate cut, Mario Draghi stressed several times that the decision had been made easier by the fact that even core countries had recently been affected by an economic slowdown. However, he downplayed falling inflation figures published this week and gave the timing of Easter this year as a reason for April’s low figure.

Unlimited liquidity will be supplied, at least until July 2014
In addition to the rate cuts, Mario Draghi announced that the ECB would continue to conduct main and long-term liquidity supply operations (MROs and LTROs) as fixed-rate tender procedures with full allotment (i.e. all liquidity requested would be supplied at rates close to the Refi) as long as necessary but at least until July 2014.

Nothing concrete for SMEs
Aside from the rate cuts, expectations had been high that further non-orthodox measures would be announced, especially as far as easing the credit crunch affecting small and medium size enterprises (SMEs) was concerned. The announcement on this point was particularly disappointing, though. Mario Draghi said that the Governing Council had decided to start consultations with other European institutions on initiatives to promote a functioning market for asset-backed securities collateralised by loans to non-financial corporations.

After Benoît Coeuré’s speech on 11 April it was clear that the solution the ECB had in mind would involve several institutions (ECB, EBA, EIB, European Commission, etc.). However, as Mario Draghi has since the beginning of the year regularly mentioned the need to reduce fragmentation in the euro area (i.e. reduce the dispersion of lending rates across euro area members, notably for SMEs), it had been assumed that discussions for a practical solution were already well advanced and that a decision could be announced as early as June’s press conference. The announcement on Thursday has thus delayed any concrete decision for several months.

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Mario Draghi happy with fragmentation reduction
Regarding fragmentation, Mario Draghi went through a long list of signs that there is some improvement. He highlighted in particular the increase in periphery bank deposits, ongoing capital inflows and narrowing Target2 imbalances.

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