Draghi masterplan a big boost for Irish economy

The European Central Bank has moved to intensify its aggressive campaign to spur the listless euro zone economy into life.

ECB president Mario Draghi’s new masterplan should provide a further boost to Ireland’s recovery, but financial markets were disappointed that he did not go a good deal further.

The latest initiative comes 11 months after the ECB decided, no less than six years after the US Federal Reserve and the Bank of England, to undertake a quantitative easing (QE) scheme in which it spends €60 billion a month buying up the sovereign bonds of euro zone countries, including those of Ireland.

Draghi insists this effort is yielding verifiable rewards and that the decision to expand the programme is – in fact – a mark of its effectiveness. But more is required. After years of pain and disorder in the single currency area, prices and economic growth are still far too low for comfort.

Ireland’s decisive turnaround is at odds with moribund conditions elsewhere in the euro zone, which still struggles to overcome the legacy of a long financial crisis and faces headwinds from the slowdown in China and other emerging markets.

“The economic recovery in the euro area continues to be dampened by subdued growth prospects in emerging markets and moderate global trade,” Draghi told reporters in Frankfurt.

After the ECB’s governors met on Thursday to set interest rates for the last time this year, the self-assured Italian set out five measures to expand the bank’s current interventions. Such moves were signalled well in advance by Draghi, who has developed a reputation for surpassing the expectations of financial markets since he took command of the ECB four years ago.

This time out, however, he stands accused of not going far enough. Markets expected more – but he did not deliver.

But what exactly is in play? The first step was to increase the price Frankfurt charges to keep money on deposit for commercial banks, the aim being to encourage them to lend the money instead of hoarding it in the ECB. The interest rate on such deposits was cut to minus 0.3 per cent from minus 0.2 per cent.

Second was the decision to prolong the bond-buying campaign until the end of March 2017 “or beyond, if necessary”, scrapping the previous end-date of September 2016. The rate at which sovereign bonds are swept up will not increase but Draghi’s pledge to continue buying bonds until the ECB sees “a sustained adjustment in the path of inflation” is seen as an implicit open-ended commitment to keep intervening.

‘Long time’

The third ECB move will see it reinvest principal payments on the sovereign bonds it holds, meaning there will no sudden stop to the bank’s endeavours whenever they end. “The conditions of a quite abundant liquidity and high excess liquidity will continue for a long, long time,” said Draghi.

The fourth move will see the ECB include the debts of regional and local governments in the QE programme. The fifth was a commitment to continue providing emergency support for euro zone banks “for as long as necessary”.

From the narrow Irish perspective, all of this still serves to underscore and prolong three key forces which have a benign impact on the advancing recovery.

These centre on the interest rates mortgage-holders pay on their home loans, the low cost to the Government of servicing the large national debt and the weakness of the euro vis-a-vis the dollar, which helps exports from Ireland.

Having declared at the outset of the QE programme last January that it would end next autumn, Draghi’s pledge to spin it out into the spring of 2017 and perhaps later means there’s no end in sight to ultra-low interest rates in the euro zone.

This carries huge benefits for Irish holders of tracker-mortgages as the main ECB rate is close to zero and the interest they pay is contractually tied to it.

“For anybody with the tracker mortgage, that interest rate is going to stay very low for a long long time,” said Prof Alan Ahearne, head of economics at NUI Galway.

Although variable rate mortgage-holders pay a lot more for their home loans but the ECB’s latest move suggests rates won’t be rising any time soon.

“They ’ve sent out a very strong signal today that monetary conditions are going to be very accommodative for a very long time,” said Ahearne. “We have very loose monetary conditions and this was about saying they were going to remain that way for even longer than they had indicated.”

Then there are euro exchange rates versus the US currency, down some 22 per cent since May 2014, and against sterling, down 11 per cent in 12 months. Despite upward momentum on Thursday against the dollar, the ECB move will ultimately put further downward pressure on the euro.

“It means the euro is likely to remain very depressed against the dollar for a long time,” said Ahearne.

Interest rates

That’s all the more so given the increasing likelihood that Draghi’s US counterpart, Janet Yellen, will soon increase American interest rates for the first time since 2006.

The same kind of downward pressure prevails in respect of the price the State pay to service its abundant debts. The yield on 10-year Irish bonds was trading just below 1 per cent before the ECB’s latest moves, down from 12 per cent in the summer of 2011.

The continuation of ECB purchases and the decision to reinvest principal repayments means such conditions will continue.

“From the bond market’s perspective, we will continue to see support for pricing in Irish debt, with borrowing costs remauining low,” said Dermot O’Leary, chief economist at Goodbody.

This augurs well, too, for the Central Bank of Ireland’s disposal of sovereign bonds it holds as a result of the deal to scrap the Anglo Irish Bank promissory note scheme.

Good as it is for Ireland, however, the ECB package left financial markets decidedly cold. European shares suffered their biggest fall for three months as Draghi spoke and the euro euro leapt against the dollar by more than two cents, its biggest rise since March. The single currency rose to $1.0860, having been close to $1.06 only hours earlier.

Some market participants attribute the volatility to traders unwinding positions adopted in anticipation of bigger steps from the ECB. Still, Draghi is perceived to have provided a minimum offering in the face of higher expectations.

“On an overall basis, the market may wonder about Draghi’s capacity to get ahead of the inflation issue,” said Garret Grogan, head of long-term interest rate trading at Bank of Ireland.

“The market was looking for a 20 basis point cut on the deposit rate, but Draghi gave us 10 basis points. The market was also looking for a two-tier deposit rate, where banks would be penalised for depositing excess reserves. We didn’t get that.”

Expectations

Grogan also said the market had anticipated that sovereign bond purchases would continue until the third quarter of 2017, six months longer than signalled. “He has extended QE but not to the extent that the market expected – and, also , he hasn’t increased the size of the monthly purchases, which remain at €60 billion per month. The market was expecting €75 billion per month.”

Draghi defended the new plan, saying the moves were “adequate”, even as he left the door open to deploy “all other instruments” if needed. Despite the arguement that market volatility would wash through the system, the sense remains that still more is required

“In the euro area, the growth is so disappointing that it needs a lot more stimulus than the ECB is providing,” said Ahearne. “Their forecasts for inflation even in 2017 inflation is well below 2 per cent and growth is well below 2 per cent so it’s a very moribund econo my they’re projecting.

“They have made borrowing costs for government practically zero so it’s free money for governments, but the problem is governments don’t want to borrow the money.”

In Draghi’s account, of course, it could all be a lot worse. Absent the original QE plan, he said, inflation would be at least half a percentage point lower next year and one-third of a point lower in 2017. “Also the impact on GDP is very sizeable. Our measures are contributing to raise GDP by almost 1 per cent in the years 2015-2017.”

The net point remains, however, that progress is too slow.