Neil Williams, Group Chief Economist at Hermes Investment Management, reacts to today’s ECB rate decision:
By ‘pushing out the boat on QE2’ a little further, cutting rates again, and setting up from June new longer-term refinancing operations for banks, the ECB probably offered as much as it could today from its emptying policy ‘tool-box’.
Euro-zone GDP may be back to its pre-crisis level, but with headline inflation still a world away from its 2% target, the damp squib of December’s QE extension, and the euro’s ascent since, Mr Draghi was always going to act today - on his first anniversary of QE.
Mr Draghi ‘pushes out the boat on QE2’ a little further
Firstly, by upping the pace of QE, to €80bn from €60bn purchases per month, and including more corporate bonds, he is turning the liquidity tap a little harder.
And secondly, to get ‘bang for his buck’, he rightly shaved interest rates again, including taking the key deposit rate further into negative territory. But, the only 10bp cut to -0.4% is puny. Aimed at discouraging cash hoarding, even more negative rates may follow if the liquidity QE throws up is to be pushed out to where it matters most – consumers and businesses.
Also, a big problem with QE is it provides cash to lend, but cannot force consumers and firms to borrow. As the ECB’s own bank lending survey reveals, credit supply at a five-year high is not being matched by loan demand, which continues to cool.
The effectiveness of negative rates will thus be in keeping bond yields down – given the ECB’s pledge to buy government debt down to a yield that’s as low as the, now -0.4%, negative deposit rate. With some two-thirds of euro-zone private borrowing – consumer and corporate – being long-yield, rather than short-rate driven, further rate cuts seems a more hopeful, albeit indirect, route to growth.
Either way, while helpful in addressing the symptom, deflation, Mr Draghi cannot alone solve the underlying problem – a monetary union devoid of economic union. This will take years. And, meanwhile, the euro remains a currency in search of a government.