Stockholm (Ekonamik) – At its June monetary policy meeting the ECB Governing Council decided to hold rates constant. It also effectively provided some forward guidance about the future of its asset purchases as well as details about the upcoming TLTRO III scheme.
Interest Rates and Asset Purchases Forward Guidance
Policy rates for the Eurozone were left unchanged at 0%, 0.25% and -0.40% for the one-week lending rate (MRO) as well as the overnight lending (marginal lending facility) and borrowing (deposit facility) rates, respectively. Providing some forward guidance, the governing council expects “interest rates to remain at their present levels at least through the first half of 2020”.
Concerning economic conditions were the main motivating factor for the decisions of the ECB. “Euro area real GDP rose by 0.4%, quarter on quarter, in the first quarter of 2019, following an increase of 0.2% in the fourth quarter of 2018,” said ECB President Mario Draghi, during the accompanying press conference. “However, incoming economic data and survey information point to somewhat weaker growth in the second and third quarters of this year. This reflects the ongoing weakness in international trade in an environment of prolonged global uncertainties, which are weighing, in particular, on the euro area manufacturing sector.” Although monetary conditions were not particularly concerning, the conclusion from the ECB was that “an ample degree of monetary accommodation is still necessary for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.”
In relation to the trade war and Brexit, during the Q&A the ECB president explained that while the governing council had been hopeful for some orderly and favourable resolution at the March meeting, they were now more bearish. “In March we might’ve hoped for a trade deal, we might’ve hoped for a decrease in uncertainties more generally. We might’ve hoped for a different evolution in the Brexit, but now it’s different.”
With regards to asset purchases, the ECB also announced it will continue to reinvest the principal payments from maturing securities purchased under its asset purchase programme “past the date when it starts raising the key ECB interest rates”, and for as long as necessary “to maintain favourable liquidity conditions”.
TLTRO – Price and Quantity Incentives
The ECB also introduced some incentives into the TLTRO III program that will be in place between September 2019 and in March 2021.
While the upcoming TLTRO III rates will generally be 10bps above the main refinancing operations (MRO) rate, banks actually using the funds to lend to the real economy above a certain threshold will receive better terms. In terms of the applied interest rates, banks will enjoy the maximum reduction “if they exceed their benchmark stock of eligible loans by 2.5% as at 31 March 2021.” Those who exceed their benchmark stock of eligible loans will get an interest rate decrease proportional to that excess of loans. “The interest rate applied to TLTRO III operations will be communicated to participants in September 2021,” the ECB clarified
The ECB also clarified volume incentives for the loans that Eurozone banks extend to the real economy funded by the TLTRO. “For counterparties that exhibited positive eligible net lending in the 12-month period to 31 March 2019, the benchmark net lending is set at zero. For counterparties that exhibited negative eligible net lending in the 12-month period to 31 March 2019, the benchmark net lending is equal to the eligible net lending in that period.”
“The calculation of the TLTRO III group’s benchmark and borrowing allowances will be based on aggregated loan data for the TLTRO III group,” the ECB explained in the accompanying press release about the details of the programme. According to the central bank, “eligible loans are defined as those to euro area non-financial corporations and households excluding loans to households for house purchase.”
Market reaction – Dovish but not as hoped
According to Carsten Brzeski, Chief Economist ING Germany, “another change to forward guidance is just another step to align the ECB’s forward guidance with market expectations; not the other way around. The pricing of the new targeted longer-term refinancing operations (TLTROs) is broadly in line with our expectations. In our view, the fact that the ECB refrained from any comments on a tiering system for the deposit facility means that speculations about an actual rate cut are still overdone. In fact, the ECB is still trying to deliver dovishness without touching rates.”
At Danske Bank, Arne Lohmann Rasmussen, Head of FI Research, and analysts Piet P. H. Christiansen, Aila Mihr and Jens Nærvig Pedersen were not very impressed with the ECB. “The price action after the press conference suggest that markets don’t expect Draghi to have been dovish enough. TLTRO3 modalities came in as broadly expected,” they commented. “Fixed income markets reacted strongly to the decision of rates not being cut in the near future, with EONIA 1y1m EONIA jumping 4bp on the decision. Long-dated yields were basically unchanged.”
Erik Meyersson, Senior Economist at Handelsbanken, noted that the TLTRO III less generous than last round”, The initial market reaction within five minutes of the release of the decision were mixed: the Euro Stoxx 600 Index and the Euro Stoxx 600 Banks index fell by -0.3% and -0.2% respectively; yields on German and Italian ten-year sovereign bonds increased by 1.1bp and 3.8bp respectively; whereas the euro appreciated by 0.23%,” consistent with missed market expectations that the ECB was going to be more dovish.
Picture courtesy of ECB