ECB - "WE ARE NOT FINISHED" - RATE CUTS AND TLTROs, NO QE

By Ruma Dubey

We in India are blessed compared to those in Europe – we get money when money is deposited in the bank but there, commercial banks will have to pay money to lodge their money with the central bank, rather than receive interest.

In a much needed effort to boost economic growth and avoid deflation in the Eurozone, the anticipated rate cuts came in, a historic move of sorts – the European Central Bank (ECB) lowered its benchmark interest rate to 0.15% from 0.25%. The ECB also reduced its deposit rate below zero, to -0.1%.

Though is really no danger of deflation creeping in, the worryingly slow economic growth rate is what prompted this rate cut. The Eurozone economy is growing only at 0.2%. Inflation fell to 0.5% in May, down from 0.7% in April, much below the ECB’s target of 2%.  Unemployment stands at 12% in the Eurozone and it is much higher in Spain, Portugal and Greece; there is real fear that in these regions it could only get worse.

After this bold and as many felt, better-late-than-never move, all eyes were on the Press Conference by President of ECB, Mr.Mario Draghi. It was widely expected that he would provide the much needed stimulus to rekindle the dying economy. Though no one expected a QE, the much expected ‘refinancing’ did come.

So we now have a new acronym – TLTROs. This stands for Targeted long-term refinancing operations. Something like the earlier stimuli of LTRO or Long term refinancing options. This is split, into two tranches, once in September and once in December. What this TLTROs means is that banks will now be able to borrow an amount equivalent to three times net lending to non-financial sector to finance new loans and this will exclude mortgages and public sector. These TLTROs will mature in four years.

The ECB says it will now consider purchasing simple and transparent asset-backed securities (ABS) - i.e quantitative easing. When questioned about QE, Draghi did not close the door; he in fact left it wide open, saying, “We are not finished”.

What also did happen as expected was that ‘sterilisation’ came to an end. In place since May 2010, it was a Govt Bond buying facility, known as Securities Market Program or SMP. This is like an opposite of QE – where new money is printed and money circulation goes up, pushing up the economy. But here, under SMP, the ECB buys assets, means it adds money to the banking system but then it sterilizes this by draining it back out. In simpler terms, every Euro the ECB spent on Govt bonds, it withdrew an equal amount from banks through interest-bearing deposits.

On asset backed securities, Draghi said that the ECB will only purchase securities that are "simple, real and transparent". He also said that the ECB does not see deflation but will remain watchful as long as inflation does not come back. Draghi's inflation projections through to 2016 have all been revised downwards, but he expects inflation to be at 1.5% by the end of 2016.

For now, the world markets are looking at these measures of Draghi as unconventional and bold. All eyes will now be on the ‘preparatory work’ work on asset purchases or QE. It could happen in 1-2 months or it could happen much later or never at all. But Draghi saying, ‘We are not done yet” is what holds the promise of some more moves expected in the next couple of months.

Cost of funds in Europe has been made insanely cheap in nominal terms but if root demand is squeezed out due to a stalled structural reform process, the cost of funds remains expensive.

How will the Indian markets react to this? Not much, as TLTROs will not affect us directly. For us, all action is now concentrated only on the Modi Govt and that is the tune to which Indian indices will gyrate.