Draghi pushes the string harder

Today, the ECB announced as expected that it will cut its deposit rate from -0.4% to -0.5%. All other monetary policy rates remain unchanged. Additionally, the bank will start another round of quantitative easing on 1 November 2019, buying EUR 20bn per month “as long as necessary”. This is below the consensus expectation of economists of EUR 30bn but to many economists’ surprise there was no end date for QE given. In reaction to these announcements, the Euro declined by about 0.5% against the US Dollar and European stocks rose.

The most interesting part of the announcement, in my view, is the expansion and extension of the Targeted Long-term Refinancing Operations (TLTRO). The maturity of TLTRO was extended from two to three years and, most importantly, the facility will include an extra incentive for banks to lend. Banks that exceed a benchmark level of net lending can expect to provide TLTRO facilities at interest rates as low as the average deposit rate over the duration of the loans. 

We all know that it is almost impossible for central banks to force banks to lend to businesses and households once the zero lower bound on interest rates is reached – something Keynes called pushing on a string. Today’s announcement by the ECB is Draghi’s final attempt to push that string as hard as he possibly can. It is, in my view, a rather desperate move given the economic slowdown and deflationary tendencies in most Eurozone countries. 

The problem with forcing banks to lend to businesses is that if businesses don’t want to borrow, then even loans at mildly negative interest rates won’t be taken on given the uncertainty for businesses. This is exactly the situation that businesses in Germany, Italy, France and other Eurozone countries are in. The economy is slowing down and export-oriented businesses in Europe are more concerned about the impact of the US-China trade war, the growth slowdown in China and the uncertainty around Brexit. It seems unrealistic to me to expect a significant uptake in lending as long as these sources of uncertainty remain. 

What seems necessary to stimulate global growth at this point in time is an end to the US-China trade war, which seems very unlikely before summer 2020 because the US Presidential election campaign is heating up and Donald Trump has no incentive to create a solution to the trade war before then since any impulse from such a win would evaporate before the elections in November. So, we should expect the US-China trade war to continue and possibly exacerbate over the next twelve months.

With Brexit likely delayed until early 2020 the main policy tool that can stimulate the Eurozone economy is fiscal policy, something that is increasingly discussed in Germany and Italy but beyond the influence of the ECB. Draghi was very clear in his press conference that he sees these limitations of monetary policy and explicitly pointed his fingers at the need for fiscal stimulus. In short, the ECB remains impotent to create inflation or stimulate growth for now and effectively has become a side show for the time being – and today even Draghi admitted that.

Unfortunately, politicians in the Eurozone are not ready to enact fiscal stimulus just yet, so nothing seems to happen in the short term. Nothing? Not quite. As I have written this morning, negative interest rates have significant unintended consequences for banks in the Eurozone and can lead to risky behaviour on their behalf that backfires dramatically in a recession. This morning the Swiss Bankers Association severely criticized the SNB’s negative interest rate policy and I think they are absolutely correct in their criticism.