Draghi has spoken, with his boldest move since taking command
The euro zone patient is still alive but it is definitely not kicking
Two years after the smooth Italian vowed to do “whatever it takes” to save the single currency, the big question now is whether his latest intervention is sufficient to shake the economy from its listless stupor.
So how long will it take? “When [do] we foresee we’ll see some outcome? It’s very difficult to say,” Draghi told a throng of reporters in the Eurotower, the high-rise headquarters of the ECB.
“Most likely, we will see immediate effects on the money markets and we will see delayed effects on the real economy attributable to this programme . . . Attributable to this programme, it will probably take three or four quarters.”
If it follows that a year might pass before the full benefit filters onto the street, Draghi held out the prospect of more ECB action if the new measures fall flat. “Are we finished? The answer is no. We aren’t finished here. If need be, within our mandate, we aren’t finished here.”
The ECB stopped short of full-blown quantitative easing, meaning it will not be buying up more government bonds in large numbers. Yet the ECB president made clear that a “broad-based asset-purchase programme” is one of the unconventional instruments the bank might yet deploy if necessary.
This was one of Draghi’s biggest initiatives since he took command of the bank from Jean-Claude Trichet in 2012. For the ECB, and indeed for the European political class at large, the stakes are huge.
The sovereign debt emergency, which called into question the very viability of the euro, remains unresolved. Although the turmoil in bond markets has settled considerably, the economies underpinning the currency are still struggling to overcome the ravages of the financial crisis which broke out way back in 2007. This is all too evident in the Irish context, and Ireland’s troubles are not unique.
So far, so sluggish
A fortnight ago, European voters handed down a brutal verdict on the contentious response to the debacle by delivering a huge increase in support for populist and nationalist parties, many of them resolutely opposed to the EU and its values.
A new clutch of economic figures illustrates the magnitude of the challenge which still confronts European leaders. Such data underscores the rationale behind the ECB’s decision to wheel out the heavy munitions.
The euro zone unemployment rate in April was 11.7 per cent, only by 0.1 percentage point down on the previous month. Progress was similarly tepid in the wider EU.
The unemployment rate there was 10.4 per cent in April, down from 10.5 per cent in March.
According to Eurostat, the EU’s statistical agency, no less than 25.47 million men and women are unemployed in the EU. The number unemployed in the euro zone is 18.75 million. That figure has dropped by 487,000 in the space of 12 months, progress of sorts but not sufficient to secure recovery after Europe’s worst crisis since the second World War. Although a multitude of complex factors are to blame, the bottom line is that the economy is not expanding quickly enough.
Another set of fresh Eurostat figures show that economic growth rose only by 0.2 per cent in the first three months this year and by 0.3 per cent in the wider EU. In spite of all the upbeat talk about the economic turnaround, growth was actually higher in the final quarter of 2014. The euro zone grew then by 0.3 per cent and the EU by 0.4 per cent.
So far, so sluggish. The euro zone patient is still alive but it is definitely not kicking and shows little inclination to do so. On top of all this is a grave new danger as the euro zone drifts towards deflation, something which can be every bit as bad as runaway inflation.
Separate figures out this week put the euro zone inflation rate at 0.5 per cent in May, well under the ECB’s target of “below but close to” 2 per cent. This was down from 0.7 per cent in April and many economists believe it could fall lower still.
Why is this of such concern to ECB policymakers? Although prices are still rising a little in euro, the basic fear is that the expectation of lower promises tomorrow will encourage consumers to delay spending their money. This would further depress demand, damaging companies, magnifying the real burden of public and private debt, and threatening a new wave of bankruptcies after years of grinding recession.
This is something of a nightmare scenario, prompting anxiety that a pernicious self-reinforcing deflationary cycle could lead Europe into a prolonged depression in the mode of Japan. True, Draghi took care yesterday to say the bank does not currently see a deflationary “self-fulfilling negative spiral” in the euro zone. But he expressed concern nonetheless about the persistence of low inflation, indicating that current trends are unsafe.
“As I often said, the longer it lasts, the higher the risks, and that’s what we are reacting to. We are reacting to a risk of a too-prolonged period of low inflation,” he said. “The longer inflation doesn’t go back, the more the governing council is in a watchful position.”
While the ECB has spurned entreaties throughout the crisis to go further, faster in its broader response to the crisis, the bank appears to have concluded in recent weeks that it has reached another moment of truth in the battle to regain the economic initiative.
There are several elements to the new package, the first being interest rate cuts. The main rate has been cut from an historic low of 0.25 per cent to 0.15 per cent, ever closer to zero. This will benefit tens of thousands of Irish home-owners who have tracker mortgages, in which the interest rates is contractually tied to the ECB. When the ECB cuts rates, their mortgage rates follow suit.
For all mortgage holders, there was further good news in Draghi’s declaration that an increase in rates set in Frankfurt is not on the horizon.
“The key ECB interest rates will remain at present levels for an extended period of time in view of the current outlook for inflation.”
There was more. The ECB entered new territory by introducing a negative interest rate of minus 0.1 per cent on money commercial banks hold on deposit with the central bank.
By charging for the security of the ECB haven, Draghi and his fellow governors are pushing banks to take their money from storage and lend more it into the economy at large. The minus 0.1 per cent rate will also apply to banks’ average reserve holdings in excess of the minimum reserve requirement.
The measure may also serve to diminish the attractiveness of euro assets to investors, helping to bring down the exchange rate and adding to inflation via rising prices for imports into the euro zone.
The second major element of the package is to funnel as much as €400 billion into the commercial banking system via a new ultra-cheap lending scheme to be known as “targeted longer-term refinancing operations” or TLTROs. This is not dissimilar to a previous LTRO initiative by the ECB, the difference this time being that banks will be obliged to utilise the money they draw down for lending to credit-starved businesses. The ultimate recipients must be “non-financial private sector” borrowers and mortgage lending for homes and public sector lending is excluded.
Given that small and medium-sized firms suffer most in the credit drought, they should be first in line to benefit. This is the targeting referred to in the TLTRO title.
In sum, this money cannot be recycled to buy government bonds. “Those counterparties that have not fulfilled certain conditions regarding the volume of their net lending to the real economy will be required pay back borrowings in September 2016,” Draghi said.
The ECB further resolved to intensify preparations to support the market in the euro zone for asset-backed securities. The proviso, however, is that any transactions are confined to simple and transparent securities whose underlying assets consist of claims against market participants in the non-financial private sector.
The bank also decided to keep open the provision of unlimited liquidity “for as long as necessary” and at least until the end of 2016.
Even as it seeks to wean healthy banks off emergency support, the ECB is keeping open the lifeline for struggling lenders.
Draghi has spoken. Next comes the response in the real economy.