On June 5, 2014, the European Central Bank (ECB) announced its first change in policy since November 2013. These actions included:
• Decreasing all three policy rates:
– Negative marginal deposit facility rate (-0.10%) for the first time in history
– Main refinancing rate cut to 0.15%
– Marginal lending facility rate cut to 0.40%
• Creating targeted longer-term refinancing operations (TLTROs) in an effort to reduce interest rates in nonfinancial markets
• Suspending “sterilization” program of previous asset purchase plan
• Intensifying preparatory work for outright purchases of asset-backed securities (ABS)
In his introductory statement, ECB president Mario Draghi sought to employ several levers in order to help stimulate economic growth and increase market inflation expectations. In one of the more poignant quotes from the Q&A, Draghi stated, “We aren’t finished here,” hinting that a broader quantitative easing program could be in the wings should market conditions deem it necessary. Below, we seek to explain the various changes in policy as well as how these measures are intended to affect monetary policy in the eurozone.
ECB Policy Rates
The interest rates on the marginal lending and deposit facilities normally provide a ceiling and a floor for the overnight market interest rates. Essentially, these rates create the range that banks charge one another for overnight borrowing.
Marginal Deposit Facility Rate: The rate of interest that banks receive on deposits with the central bank.
Decreased from 0.00% to -0.10% (in line with expectations)
Marginal Lending Facility Rate: The rate at which banks obtain overnight liquidity from the central bank.
Decreased from 0.75% to 0.40% (0.60% expected)
With interest rates now below zero for deposits at the ECB, this policy is meant to entice banks to lend excess cash rather than park it at the ECB. While the impact of negative interest rates is mostly symbolic, it does continue to bolster Draghi’s focus on reversing low levels of inflation.
Open Market Operations
Main Refinancing Rate: The so-called benchmark interest rate for European monetary policy.
Decreased from 0.25% to 0.15% (0.10% expected)
This rate is targeted by the ECB through one-week liquidity-providing operations referred to as main refinancing operations (MROs), as well as three-month liquidity-providing operations, referred to as longer-term refinancing operations (LTROs). MROs seek to manage short-term liquidity and interest rate targets, while LTROs seek to provide additional longer-term financing support to banks. The initial announcement of three-year LTROs in 2011 and 2012 resulted in an injection of just over €1 trillion on a gross basis.1
In this most recent announcement, the ECB expanded its lexicon to include targeted longer-term refinancing operations, which seek to improve bank lending to the euro nonfinancial private sector. Accessing this new facility will begin in two tranches in September and December and will continue quarterly for the next two years. The initial size of this program is estimated to be approximately €400 billion. The interest rates for each of the operations will reflect the main refinancing rate at the time plus a fixed spread of 10 basis points. All TLTROs from this initiative will mature in September 2018. This policy was introduced in an effort to increase lending by banks into the real economy through cheap capital.