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Thursday, June 05, 2014 12:20 PM


ECB Pulls Out Pea Shooter, Fires, Misses Target


In a widely expected move this morning, ECB president Mario Draghi announced negative interest rates, the first-ever move for a major central bank.

The deposit rate in Europe is now negative 0.10%. The ECB also lowered the benchmark rate from 0.25% to 0.15%.

In a display of puffery, Draghi announced “we aren’t finished here”.

The Financial Times provided a few more details in its report: ECB unveils extraordinary moves to fight deflation, lift economy

The ECB will offer cheap longer-term loans, known as a targeted longer-term refinancing operations, which will resemble the structure of the Bank of England’s Funding for Lending Scheme.

There will be four TLTROs, all maturing by September 2018, worth up to €400bn. “A number of provisions will aim to ensure that the funds support the real economy. Those counterparties that have not fulfilled certain conditions regarding the volume of their net lending to the real economy will be required to pay back borrowings in September 2016,” Mr Draghi said.

The ECB will also continue to provide shorter-term cheap loans to banks at fixed rates until at least the end of 2016.

Mr Draghi said the ECB had “decided to intensify preparatory work related to outright purchases” of asset-backed securities, a limited form of quantitative easing.
Pea Shooter, Not a Bazooka

The TLRTO refinancing operations will not apply to mortgages out of fear of overstimulating housing.

Although I believe these actions will have the effect of a pea shooter,  this is not a call for the ECB to do more.

The ECB has an irrational fear of falling prices and should not have done anything at all. Contrary to popular myth, falling prices do not cause consumers to delay purchases. The problem is debt, not low prices. For further analysis, please see Deflation Theory Reality Check.

We are in this mess because central banks have blown serial bubble after bubble, each with a bigger amplitude.

ECB Goals

The ECB hopes to spur lending, especially to small businesses, stop deflation, cheapen the Euro, increase exports, and improve economic growth.

Will the ECB's Actions Work?

In a nut shell no.

Negative interest rates were tried before and they accomplished nothing. Denmark tried a -0.2% rate in 2012 and it did not spur lending, nor did negative rates cause customers to pull money out of banks as some feared.

As I have noted on many occasions, banks lend if and only if two conditions are met.

  1. Banks are not capital impaired
  2. Banks believe they have credit-worthy borrowers on a risk adjusted basis

What about the housing bubble? Banks knew they did not have credit-worthy customers but they thought they could dump the assets on others. Banks also believed no one would ever walk away from houses. Those were bad assumption and banks seriously misjudged the risks. Banks do see such risks now.

In this case, Draghi's moves will not spur lending because the ECB did nothing to make customers more credit-worthy. To top it off, the ECB is tightening capital requirements.

Instead of lending more, banks will raise fees to make up for the loss they take on parking money with the ECB. And if the ECB make the deposit rate negative enough, there will be a run on the bank by depositors.

All in all, slightly negative interest rates will have a slightly negative impact on lending.

The ECB hinted at QE, but in practice will be unable or unwilling to match the scale of Fed QE actions. And Germany will scream every step of the way on any move.

Thus, there is no reason to believe future ECB actions will substantially cheapen the euro or increase exports.

In short, the ECB's actions cannot possibly accomplish anything except perhaps fuel even bigger asset bubbles in stocks and bonds.

Euro 5 Minute Chart



It is risky to make assumptions based on price movements in a single day, nonetheless, today's action in the euro was interesting.

After opening lower, the euro is now in positive territory. This is arguably an early indication of the Forex market's opinion on the ECB's pea shooter approach.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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