Summary of ECB decisions on March 10:
On March 10, 2016, the ECB took six measures (the most relevant are in bold):
– 1) Lowering the refinancing rate from 0.05% to 0% (see our explanation here on the different ECB rates) and 2) lowering the marginal lending facility rate to 0.25%
– 3) Lowered the deposit facility rate from -0.3% to -0.4%
– 4) Increased QE from €60 billion to €80 billion in monthly purchases
– 5) The ECB will now purchase non-financial corporate bonds with investment grade ratings, i.e., those considered relatively safe.
– 6) A series of four new TLTROs (four-year loans granted by the ECB to banks) will be conducted each quarter starting in June 2016.
Questions and answers about the decisions made on March 10:
– If we had to pick just one, which measure is the most important?
The last one (TLTRO) seems the most interesting. Banks will be able to obtain long-term loans at very low rates (the rate is set at the refi rate for the loan, which in theory is 0% for the first loans). As Draghi has repeatedly said, this measure is very important in an environment where financing costs for banks are highly volatile. These loans will provide both additional stability for banks and very low financing costs, which should help to support credit supply and keep lending rates low.
– Why was the refinancing rate lowered?
The cut in the refi rate is almost entirely linked to the new TLTRO program: lowering the refi rate makes TLTRO loans more attractive to banks, since the cost of borrowing for banks is basically equal to the refi rate. The cut in the refi rate has no other significant impact in the current environment of abundant liquidity (marginal effect on the EONIA).
– Why was the deposit facility rate lowered?
Clearly, the aim here is to lower the exchange rate (in addition to the signaling effect) (beware of confusion, see our post here). However, with markets cooled by Draghi’s comments, the effect on the exchange rate was quickly masked by these new expectations.
– Why not introduce a system of partial taxation on bank deposits?
Some expected it, but the ECB did not take this step. It could have applied the negative rate only to part of the banks’ excess liquidity through what is known as a « partial taxation » system. This system has certain advantages, notably reducing the adverse effects of negative rates. However, the ECB chose not to implement such a system. Why? According to Draghi, because of « the inherent complexity of such a system in the context of the euro area. » Draghi may have been bluffing on this point in order to surprise the markets in the future. It seems likely that a future cut in the deposit rate could only be achieved with a partial taxation system for reserves.
– Why did the ECB include corporate bonds in its program?
This is certainly only related to measure 4): increasing the amounts purchased through QE. The ECB simply wants to ensure that it has enough assets to buy, so it has expanded QE to include corporate bonds. (To consider that « the measure ultimately has a direct effect on interest rates linked to corporate bonds » would be to forget that the fall in sovereign bond rates also leads to a fall in corporate bond rates in practice).
