Evolution of Nonstandard Monetary Policy
The ECB has technically had this authority, often referred to in the press as Outright Monetary Transactions, since 1999. The ECB first deployed these policies in June 2009 when it began purchasing covered bonds in order to ease liquidity and lower financing rates. During the height of the eurozone crisis in 2010, the ECB expanded this program into what is now called the Securities Markets Program (SMP).
Developed as temporary programs, the European Financial Stability Facility (EFSF) and the European Financial Stabilization Mechanism (EFSM) were established by European Union (EU) member states in order to provide assistance during times of crisis. Their primary function was to purchase one- to three-year European government debt in the secondary market in order to lower borrowing costs without violating the “no bailout” clause of the Maastricht Treaty. In order to fund these operations, the EFSF issued bonds to purchase debt of EU member states. At the time, there was concern that this new facility was essentially “printing money,” which could lead to unhealthy increases in inflation and decreases in the exchange rate. In order to allay those fears, the ECB would “sterilize” all asset purchases by draining liquidity from the money supply at weekly auctions.
As a more permanent solution, EU member states announced the formation of the European Stability Mechanism (ESM) in 2012. This facility would serve as a liquidity bridge for euro-area countries in distress to give them time to make changes in fiscal policy to ensure medium-term economic strength. Additionally, policy makers would also look to use the ESM as one way to help troubled banks recapitalize. At present, the ESM has a maximum lending capacity of €500 billion.2
Changes in Nonstandard Policy: Suspending Sterilization & Readying Purchases
Fast-forward to the meeting on June 5, 2014: The ECB announced that it would be suspending sterilization efforts from the SMP in order to increase inflation expectations and potentially weaken the exchange rate. This is expected to inject an estimated €175 billion into the banking system.3
In order to further condition the market, ECB president Draghi announced during his press conference that the ECB was preparing a “real, simple and transparent” asset-backed securities purchase program. While widely hinted at leading up to the announcement, the initiative is attempting to increase the bank’s ability to lend money into the real economy for asset purchases. By directly targeting asset-backed securities, the ECB is seeking to encourage bank lending in this specific segment of the market.
While Draghi reiterated that the ECB could do more to help the eurozone economy if needed, he continued to sound confident that economic activity was continuing to recover. Over the coming weeks, we will seek to provide greater clarity as to the direct impact these changes in policy will have for the euro, equities and bond markets.
1Source: ECB, May 2012.
2Source: ECB, as of 2/2/12.
3Source: J.P. Morgan, as of 6/5/14.
Important Risks Related to this Article
Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments focused in Europe may be significantly impacted by events and developments associated with the region, which can adversely affect performance.