As widely expected, the European Central Bank approved a new stimulus package on Thursday, cutting interest rates and stepping up bond purchases, without an end date, to support economic growth and inflation expectations. In addition, the central bank announced a tiering system to mitigate the negative impact on the banking sector. Although this will support the current risk-on environment over the short term, the actual game changer would be an ambitious and credible programme of fiscal easing in Europe.
WHAT HAS BEEN DECIDED?
The ECB has revised down its growth and inflation forecasts for 2019, 2020 and 2021. Falling inflation, Germany flirting with a recession and a global trade war have impacted domestic confidence and made the central bank reactivate its monetary efforts.
- As expected, the ECB lowered the deposit rate by 0.10%, to -0.50%, in line with our expectations.
- The ECB announced some changes to its TLTRO (Targeted Longer-Term Refinancing Operations) programme to preserve favourable bank lending conditions. The programme has been extended from two to three years under more advantageous conditions, such as a reduced interest rate, between 0% and -0.50%.
- Draghi also announced a two-tier system to limit the impact of negative interest rates on banks, exempting six times the reserve requirements of each bank, and lowering the negative interest rate impact on the system by EUR 2 billion.
- Finally, the central bank launched a new round of quantitative easing, starting its EUR 20 billion monthly asset purchase programme in November “for as long as necessary”. This is the game changer: the duration of the QE will depend on the state of the economy, and has no pre-defined end date.
- In addition, Draghi and Christine Lagarde, earlier during recent EU Parliament hearings, urged European governments to step up their fiscal policy efforts. “Fiscal policy should become the main policy”, Draghi stated. “In view of the weakening economic outlook and the continued prominence of downside risks, governments with fiscal space should act in an effective and timely manner … All countries should reinforce their efforts to achieve a more growth-friendly composition of public finances.”
The ECB has delivered, with a broad monetary easing package. All levers, including the deposit rate cut, the tiering system, the QE and the conditionality on forward guidance, have been activated. If some measures have been at the lower end of the expectations, these have been counterbalanced by a QE programme that is not dependent on the calendar, but on the state of the economy.
The ECB hasn’t let markets down, confirming the positive tactical view on equities that we have been implementing since August 6th and more recently by increasing our global equity exposure via EMU and emerging markets. However, the Federal Reserve’s communication next Wednesday will be another key event, during which its key interest rate will probably be cut by another 25 bps. The real game changer will nevertheless have to come from fiscal policy. Perhaps the German ‘Climate Summit’ next Friday will open the door to some fiscal stimulus.