Mario Draghi unleashed a bold new show of force by the European Central Bank, paying commercial banks to boost lending as the ECB cut its main interest rate to zero and moved to buy corporate bonds in its stimulus campaign.
The intervention was far bigger than anticipated, but markets delivered a sharp retort after Mr Draghi signalled the ECB may have reached the limit of negative rates it charges banks to hold money which they would otherwise lend.
With economic prospects in the euro zone deteriorating and inflation in decline, the ECB’s objective is to spur growth and inflation and avert the threat of deflation. Insisting the ECB had plenty of ammunition at its disposal, he said there would have been “a disastrous deflation” in the euro zone if the bank had not made previous interventions.
As Mr Draghi took the ECB deposit rate lower by 0.10 percentage points to minus 0.40 per cent, he made little of German claims that such rates present a threat to the profitability of banks and life insurers. “The experience we’ve had with negative rates, in our case at least, has been very positive.”
The new plan includes four longer-term loan schemes for banks to encourage lending. Borrowing terms in the scheme can be as low as the minus 0.04 per cent rate on the deposit facility, meaning the ECB will pay banks to take its cash if they show they are lending it on to households and firms.
The first news of the ECB manoeuvres sent the euro down by 1.6 per cent against the dollar. However, the single currency advanced by as much as 2 per cent after the ECB chief told reporters in Frankfurt that he did not expect to cut rates further and would concentrate instead on quantitative easing.
‘ Worst of both worlds’
“To us this is the worst of both worlds – taking the deposit rate further below zero but with verbal interventions unwinding positive market effects,” said Justin Doyle, senior currency dealer at Investec.
Global stock markets fell, with the pan-regional FTSEurofirst 300 index closing 1.8 per cent lower. The Dublin market dropped 1.49 per cent, bringing the Iseq to 6,189.41. The State told short-term debt at a negative yield yesterday and Irish 10-year bonds changed hands at about 0.81 per cent, close to a record.
ECB bond purchases were raised to €80 billion per month from €60 billion but there was no extension to the timeline. Still, investment grade bonds issued by “non-bank corporations” will now be eligible for purchase.
“Although the lack of programme extension beyond March 2017 leaves the additional balance sheet expansion via QE at an unimpressive €240 billion, this is more than offset by the more front-loaded pace of purchases and the inclusion of non-bank corporate bonds in the list of eligible securities,” said Marco Valli at UniCredit.
Mr Draghi said interest rates will stay “very low for a long period of time” and well past the horizon of bond purchases.
“From today’s perspective and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further.”
Eugene Kiernan, head of strategy at Appian Asset Management, said it was clear the road to higher inflation was longer than perceived previously. “Draghi seemed to have ruled out further cuts in interest rates – but did he have to? Once again he looks for fiscal policymakers to do their bit rather than leave it all to monetary policy,” Mr Kiernan said.
