On September 4, the European Central Bank (ECB) took further accommodation to support the economic growth environment in Europe.1 As a result, the euro collapsed about 1% immediately after the news, while European stocks rose on prospects for more monetary policy easing. This reaction mirrors what we saw in Japan in 2013, and it strengthens the case for taking the euro out of Europe. Why?
Lower Interest Rates
At last month’s meeting, ECB president Mario Draghi stated that, for practical purposes, interest rates had reached a lower bound, barring some technical adjustments. Yet at this meeting, the ECB lowered rates further by 10 basis points across all its key policy rates. Hence, the ECB is effectively charging banks 20 basis points annually to keep excess cash parked at its deposit facility. This then incentivizes banks to extend loans that will jump-start the lackluster Euro system credit cycle.
The newly announced rates are:
• The main refinancing operations of the Eurosystem was lowered to 0.05%.
• The marginal lending facility was lowered to 0.30%.
• The deposit facility was lowered to -0.20%.
Credit Easing with Expanding Balance Sheet
Draghi also announced that the ECB would start purchasing nonfinancial private sector assets. The goal of these actions is to ease credit conditions for the banks, as they extend 80% of all lending activity in the euro area, according to Draghi’s testimony. This is from the ECB release:
“The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June. In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014. … The newly decided measures, together with the targeted longer-term refinancing operations, which will be conducted in two weeks, will have a sizeable impact on our balance sheet.”