ECB readies package of rate cuts and targeted measures

Wednesday 14 May 2014 14.06
Five people familiar with the ECB measures being prepared detailed plans involving a potential rate cut
Five people familiar with the ECB measures being prepared detailed plans involving a potential rate cut

The European Central Bank is preparing a package of policy options for its June meeting, including cuts in all its interest rates and targeted measures aimed at boosting lending to SMEs.

Five people familiar with the measures being prepared detailed plans involving a potential rate cut, including the ECB's deposit rate going negative for the first time.

The package offers some stimulus for the euro zone economy but falls short of the large-scale effect the ECB could unleash with a major programme of quantitative easing (QE) - money printing to buy assets. Such a QE plan is still some way off.

A June rate cut is "more or less a done deal", said one of the five sources who spoke to Reuters on condition of anonymity.

A second source echoed that sentiment, and added: "This will be the first major central bank to move to a negative deposit rate. That would move the exchange rate."

ECB executive board member Peter Praet also told German weekly newspaper Die Zeit the bank could cut its deposit rate into negative territory.

This may form part of a package of policy measures that could also include a targeted long-term refinancing operation (LTRO).

The latter is a method of boosting bank liquidity in the euro zone with an eye to increasing lending. 

The first two sources spoke to Reuters of a cut of 10-20 basis points, probably in all three ECB rates. The main refinancing rate is currently at 0.25%.

Both sources expected the move to bring down the currency exchange rate but said the ECB had made no calculation of how much it was likely to fall by, and had no target for the euro.

The ECB declined to comment when asked about the plans.

ECB President Mario Draghi said last week the Governing Council was "comfortable with acting next time" - its June 5 policy meeting - but wanted to see updated economic projections from the bank's staff first. 

Negative deposit rates on the way?

"Negative deposit rates are a possible part of a combination of measures," Praet told Die Zeit. "We are preparing a range of things. We could again lend banks money for a longer time frame, possibly with conditions attached."

Praet did not see the ECB embarking on US-style QE unless economic conditions deteriorated: "I think it will only come to that if the euro zone economy and inflation develop significantly worse than we expect," he said. 

The ECB's deposit rate already stands at zero and a cut into negative territory would see it essentially charge banks for holding their money overnight - a move that could spur more lending, though analysts are unsure how banks would react.

The ECB is concerned by the euro's strength and low inflation, which Draghi is worried could get stuck in what he calls a "danger zone" below 1%. At 0.7%, inflation is running well below the ECB's target of just under 2%.

The bank is also concerned about weak lending to SMEs. 
Another source was less sure the new staff forecasts would merit policy action but confirmed a package was under discussion should the Council decide to act. Some analysts believe a small cut in the ECB's interest rates would have little impact. 

Should it decide to cut rates, the ECB is looking at also deploying either a targeted long-term loan operation, or LTRO, or else announcing a purchasing programme to buy asset-backed securities (ABS) comprised of bundled SME loans.

The targeted LTRO, which ECB staff have been working on for weeks, would come with conditions attached on achieving a measurable increase of banks' lending to SMEs.

The operation could be even longer than three-year LTROs the ECB deployed in late 2011 and early 2012 to head off a funding crunch. 

As an alternative to the targeted LTRO, the ABS purchase plan would see the ECB buy bundled packages of SME loans. This could be announced in June with a view to coming into operation late this year, two sources said.

The idea behind this second option is to build the market in Europe for SME loans bundled as ABS, with a view to making it larger and more liquid to aid the flow of credit to the smaller firms that form the backbone of the euro zone economy.

While developing this purchase plan, the ECB is also lobbying banking regulators in Basel to loosen the capital requirements on banks holding high-grade ABS.

One of the five sources said the ABS purchase idea was on the table but, because it would take time to make it operational, the measure might not be announced in June.

The tools being prepared are consistent with measures Draghi identified in an April 24 speech in which he explained how the ECB would respond to three broad scenarios.

To respond to a de facto tightening of monetary policy caused by market moves like further euro gains, Draghi indicated the ECB could cut rates.

To deal with problems transmitting its policy to all parts of the euro zone, he said the bank could deploy an LTRO targeted at encouraging bank lending or an ABS purchase programme.

Under a third scenario of a deterioration in the medium-term inflation outlook, Draghi said last month the ECB could respond with a "broad-based asset purchase programme" - potentially QE.

However, just a few days later - at a meeting with German lawmakers - Draghi played down the prospect of QE any time soon.