ECB rescue: less to it than meets the eye

“You can’t say Mario Draghi isn’t doing his part,” says The Wall Street Journal. The president of the European Central Bank (ECB) surprised markets last week with another round of interest-rate cuts and promises of more monetary stimulus to ward off deflation and bolster growth. He cut the ECB’s main lending rate from 0.15% to 0.05%.

He also increased the negative deposit rate – the rate banks pay for holding deposits at the central bank – from -0.1% to -0.2%. Banks are typically paid interest for depositing money with a central bank, but the ECB has made the rate negative so that banks are effectively paying it to park money there. This was done to spur bank lending.

A new round of stimulus

In addition, Draghi also announced that the ECB would purchase asset-backed securities (ABS), or bundles of loans, from banks and other financial institutions. The ABS will include mortgage-backed securities.

The ECB will also buy private debt securities called covered bonds. This new measure is also intended to stimulate lending by reducing the interest rates on ABS and freeing up space on banks’ balance sheets.

Exactly what, and how much, the ECB will buy will be revealed next month. However, it indicated that it is aiming to raise the value of loans on its balance sheet to 2012 levels. That implies a €750bn expansion from its current size of €2trn. The asset-purchase programme will begin in October.

Will it help? Can all this kick-start a turnaround in Europe’s lacklustre economy? The changes in interest rates are “negligible”, as Clive Crook puts it on The bond-buying programme is “explicit monetary stimulus” and certainly “something of a departure” for the hitherto very cautious ECB. But there may be less to it than meets the eye.

For starters, the ABS market is not a very big one. There are only around €300bn ABS outstanding in Europe at present, says The Wall Street Journal. A programme of cheap loans for banks may encourage them to create more such securities, but this will take time.

Meanwhile, Draghi has said the ECB will concentrate on high-quality assets, though it may also buy dodgier ones if governments provide a guarantee against losses (thereby perhaps making banks more willing to issue riskier loans).

Note too that adding €750bn to the ECB balance sheet “is not as big a deal as it seems”, says James Mackintosh in the FT. It amounts to an increase of 33%. But since 2009 the Bank of England has increased its assets by 70%; the US FederalReserve by 100% and the Bank of Japan has gone even further.

“More is needed” – especially since the evidence shows that QE helps through “a critical mass effect”, says Ambrose Evans-Pritchard on “It must be carried out swiftly and with maximum force” if it is to bolster overall confidence and expectations of higher inflation.

QE is getting closer

The ECB programme is a far cry from the US, UK and Japanese central banks’ mass purchases of government bonds, known as quantitative easing (QE). That step remains politically contentious within the ECB, because Germany is nervous about large-scale money-printing programmes.

Another problem is that European banks, unlike their American or British counterparts, have yet to clean up their balance sheets, so they will be loath to make new loans. But economic stagnation and threats of deflation in the European economy are fuelling fears of a Japan-style malaise.

So the odds are that “the ECB will eventually have to stop tiptoeing around and take the plunge into a programme of full-scale quantitative easing”, says Capital Economics. That’s always good news for equities – but might it come too late to stave off a multi-year slump?

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