In case you were too busy reacting to Time Magazine’s latest Person of the Year, you should know that the European Central Bank (ECB) has just rolled out its monetary policy changes. What’s more, head honcho Mario Draghi has also given a presser afterwards and provided more details.
Here are five things you need to know about their announcements:
QE is still on like Donkey Kong
The ECB hasn’t made any changes to its official interest rates. The refinancing rate is still at 0.0%, the marginal lending rate remains at 0.25%, and the main deposit rate is frozen at -0.40%.
The asset purchasing program (APP), however, is another story. For starters, the ECB will now extend its QE program until December 2017 (APP was previously scheduled to end in March), but scaled down its monthly asset purchases from €80B to €60B starting on April 2017.
More importantly, the ECB has warned that if the economic outlook “becomes less favorable or if financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation, the Governing Council intends to increase the programme in terms of size and/or duration.”
Basically, the ECB’s quantitative easing (QE) program is still on like Donkey Kong. The reduction of monthly asset purchases may sound a lot like “tapering,” but Draghi was quick to denounce the label, saying that “the natural way to look at a word like that is to have a policy whereby purchasers would gradually go to zero, and that’s not been discussed or, as a matter of fact, it’s not even been on the table.”
For forex newbies out there, you should know that it’s crucial for accommodative central banks like the ECB to reduce their asset purchases without the markets interpreting the move as “tightening.” This is to prevent sharp reaction on domestic bond prices.
Changes in APP parameters
In a move to calm speculations that the ECB is running out of bonds to buy, Draghi and his team gave themselves a little more room by making adjustments to their APP.
The ECB can now buy bonds with a yield below its deposit rate (-0.40%). This means that they can now buy bonds for more than their face value, which would effectively incur losses when the bonds mature. The maturity of bonds eligible for the APP is also extended from 2-30 years to 1-30 years, which would allow the ECB to steepen the short-term end of the bond yield curve.
Last but definitely not the least, Eurosystem central banks will accept cash as collateral in their public sector purchase programme (PSPP) facilities starting on December 15 this year.
The goal is to boost activity in the repurchase agreements markets, which took a hit when the ECB hoarded high-quality government bonds, the most used collateral for repo agreements. The limit is set at €50B and the option will be offered at a rate equal to the lower of the rate of the deposit facility minus 30 basis points (ie currently -70 basis points) and the prevailing market repo rate.
Staff projections ≠ ECB’s goals
The ECB has a pretty steep hill to climb before it reaches its goals. See, the ECB staff only estimates inflation to rise by 1.3% in 2016, 1.5% in 2018, and 1.7% in 2019.
When asked if that counted as meeting the ECB target of inflation “below but close to 2.0%,” Draghi said “Not really, so we have to persist.” Meanwhile, GDP will only grow by 1.7% this year and in 2017 before slowing down to 1.6% in 2018 and 2019. Yikes!
The euro reacted as if the ECB added more stimulus
Because that’s what the ECB effectively did even though Draghi tried really hard to satisfy those who want less easing (Germany and other central banks) and those who want more stimulus (everyone else).
EUR/USD hit an intraday high of 1.0873 before market players did the math and came up with more easing than they initially expected and dragged the pair down to 1.0612. Ditto for EUR/JPY, which shot up to 123.36 before falling back down to 121.04 and EUR/GBP, which fell from a high of .8570 to its .8432 closing price.
Draghi can’t call the decision “consensus”
In his presser, Draghi called their decision “very, very broad” consensus, mainly because Germany’s Weidmann dissented to the decision to extend their QE program. If you recall, Germany has been pushing for tighter policies from the ECB, saying that prolonged ultra-loose policies delay critical reforms in the euro zone’s weaker economies.
Back in 2012 Draghi warned that the ECB will do “whatever it takes” to preserve the euro. But after years of spending bajillions of euros and still not meeting their goals, “whatever it takes” now includes being creative in their policy announcements.
They now have to find a way to keep doing what they’re doing while reassuring those who are calling for tapering that they’ll eventually tighten their policies. At the same time, they also have to communicate to those that need stimulus that the ECB will continue to provide support, even as its options are becoming limited.
At the end of the day, we have to judge the ECB’s policies by its actions and, based on the latest set of policy changes, it looks like easier monetary policies are here to stay.
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