Financial markets captured all of the attention in yesterday’s ECB meeting, in which there was a change in their forward guidance, signaling the hold in rates “at least through the end of 2019” along with a new round of liquidity measures, in order to keep the credit flowing. Apart from these new measures, the ECB forecast for the GDP growth was revised down for the eurozone. As Dave Lafferty, chief market strategist at Natixis IM, summarised: “If you were waiting for evidence that European monetary policy has turned the corner, you’ll definitely be disappointed… if not surprised.”
Interest rates were remained at their present levels at least through the end of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.
Draghi essentially confessed to what everyone already knows – the European economy , after a short bout of strength in late 2017/early 2018 – is decelerating again. As importantly, several years of negative overnight rates and billions in asset purchases have done nothing to push up inflation or inflation expectations.
Historically, central bank projections typically evolve slowly in 0.1 or 0.2 percentage point changes. While a reduction in the growth estimate was expected, the outsized downgrade from 1.7% to 1.1% for this year was eye-opening.
In response, Draghi announced several policy changes punctuated by a new set of TLTROs starting in September 2019 and ending in March 2021, each with a maturity of two years. The TLTROs were expected given the impending roll-off of loans next year where discontinuing the program would have been tantamount to tightening. Kudos to the council for dressing up these measures, but investors know it just the same old medicine in a new bottle.
For Dave Lafferty, new TLTROs “may be the best the ECB can offer given that further reducing overnight rates below 0% taxes banks who are already struggling.” Meanwhile, additional asset purchases are limited as there are no more high quality bonds to buy.
The great victim of the previous situation was the European banking as uncertainties about the future of its margin of interest became stronger as well as the skepticism on its future profitability. For example, in Spain, financial entities declined significantly, with Sabadell losing -7.25%. In fact, the bad performance of the banking sector was key to explain the negative close of the Ibex-35 (-0.5%).
The euro fell to 1.12 USD/EUR level and 10 years German Buund yiled declined below 0.10% to its lowest level since October 2016. , a natural response to accommodative tinkering. “A more cynical explanation of euro depreciation is that investors realize that growth may be ‘lower for longer,” says Lafferty.
Draghi is discovering that extraordinary policy initiatives may stave off depression, but they have shown little ability to create and sustain an economic expansion. It is the very picture of ‘pushing on a string,” concludes the expert at Natixis.
