European Central Bank steps up stimulus efforts

“With the growth recovery stalling and the threat of deflation looming, the ECB finally stepped off the sidelines today, cutting its main refinancing rate to 0.15% and taking the deposit rate down into negative territory (-0.1%). But it didn’t stop there, announcing a suite of further measures,” says CIBC World Markets in a research note.

Along with the rate cuts, TD Economics notes that the ECB also announced a new Targeted Long-Term Refinancing Operation (TLTRO), which will enable European banks to borrow more from the ECB. This amounts to a total of roughly €400 billion, it says, as the central bank aims to encourage lending.

Additionally, TD says that the ECB also announced the suspension of its weekly sterilization of liquidity, which should boost money supply. And, it set out plans for outright purchases of asset-backed securities. “The ECB will consider buying ‘simple and transparent ABS’ with claims against the euro area nonfinancial sector,” it says.

“The European Central Bank just about met market expectations on rate cuts and then delivered on additional measures,” TD says, noting that the rate cuts had already largely been priced into the markets.

“Bringing the deposit rate into negative territory takes the ECB into uncharted waters. There are few instances of central banks using negative rates and certainly it has never been done by so prominent a central bank,” TD says. “Time will tell whether cutting the deposit rate will encourage banks to increase lending, will lead to capital outflows, or whether banks will treat this as a cost of operating and simply pass it on to consumers and businesses. Some combination of these three outcomes is probable.” Overall, these measures, TD says, should combine to boost lending, growth, and inflation.

However, economists suggest that the bank may have more to do. Indeed, TD says Eurosystem staff also downgraded their economic outlook this year to just 1% real GDP growth, down from 1.2%, but pushed up the 2015 forecast to 1.7% from 1.5%. The forecast for 2016 was left unchanged.

“Today’s announcements do not materially change the outlook for the euro zone, but they should constrain the euro and should help anchor inflation expectations, which was the main goal the ECB was looking to achieve,” TD concludes.

“The steps taken show that the ECB is not going to stand back while Eurozone growth stalls and the deflation bug threatens to bite,” CIBC says. “However, even though today’s announcements have helped weaken the euro further, the currency remains much stronger than its mid-2012 lows and even more action could be necessary in order to stimulate the economy through that channel. Should the ECB make good on the promise of asset purchases, achieving a weaker currency, we remain more optimistic than the consensus for Eurozone growth, particularly in 2015.”

CIBC says that the ECB has “taken a good first step towards a weaker euro.” However, it suggests that more will likely need to be done. “To achieve a large enough depreciation to make a significant difference to trends in growth and inflation, policymakers will have to make good promises of even further action,” it says.

Nevertheless, CIBC says that today’s measures indicate that the ECB is signalling a newfound drive to combat deflation and support the recovery. “One that we think will see them achieve greater success in weakening the currency in the future,” CIBC says. It is continuing to call for above consensus growth of 1.3% this year and 1.9% in 2015.

“The ECB has now effectively set a floor on interest rates and therefore no further cuts should be expected. However, extending the full-rate fixed allotment refinancing operations is a powerful signal that rates will remain at or near their current level well into 2016,” TD notes, adding that the ECB “has definitely left the door open for further monetary easing down the road.”