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Thursday, September 04, 2014 1:51 PM

ECB's €1 Trillion Stimulus Gamble: ECB Pulls Out Bazooka, Cuts Rates, Buys Assets; Will this Stimulate Lending?

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ECB president Mario Draghi pulled out a bazooka today announcing asset purchases. The ECB also cut interest rates to 0.05% (from 0.15%) while offering negative 0.2% on funds parked with the ECB.

Here are some details from the ECB Announcement.

  • Governing Council decided today to lower the interest rate on the main refinancing operations of the Eurosystem by 10 basis points to 0.05% and the rate on the marginal lending facility by 10 basis points to 0.30%.
  • The rate on the deposit facility was lowered by 10 basis points to -0.20%.
  • The Governing Council decided to start purchasing non-financial private sector assets. The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June.
  • In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014. The detailed modalities of these programmes will be announced after the Governing Council meeting of 2 October 2014. The newly decided measures, together with the targeted longer-term refinancing operations which will be conducted in two weeks, will have a sizeable impact on our balance sheet.
  • The Governing Council sees the risks surrounding the economic outlook for the euro area on the downside. In particular, the loss in economic momentum may dampen private investment, and heightened geopolitical risks could have a further negative impact on business and consumer confidence. Another downside risk relates to insufficient structural reforms in euro area countries.
  • According to Eurostat’s flash estimate, euro area annual HICP inflation was 0.3% in August 2014, after 0.4% in July. This decline reflects primarily lower energy price inflation, while the other main components remained broadly unchanged in aggregate. Inflation rates have now remained low for a considerable period of time. As said, today’s decisions, together with the other measures in place, have been taken to underpin the firm anchoring of medium to long-term inflation expectations, in line with our aim of maintaining inflation rates below, but close to, 2%. On the basis of current information, annual HICP inflation is expected to remain at low levels over the coming months, before increasing gradually during 2015 and 2016.
  • The September 2014 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation at 0.6% in 2014, 1.1% in 2015 and 1.4% in 2016. In comparison with the June 2014 Eurosystem staff macroeconomic projections, the projection for inflation for 2014 has been revised downwards. The projections for 2015 and 2016 have remained unchanged.

Euro Response

The Euro has been declining for weeks in expectation of an announcement. Judging from today's reaction, the market may not have expected this big of an announcement.

ECB's €40bn Stimulus Gamble

Details will not be announced until October, but the Independent seems to have some in advance. Please consider ECB's €40bn Stimulus Gamble to Boost European Economy.
ECB boss Mario Draghi is expected to outline plans to inject as much as €40bn into the flagging economy.

According to US investment bank JP Morgan Chase, he plans to buy bundles of bank loans which would be paid for by effectively creating money.

This extra money would be paid to the banks that had owned the bonds, so that they in turn can provide much-needed loans to businesses.

The aim is to stimulate economic activity by increasing lending, creating jobs and eventually allowing more people to spend money in the eurozone.

Justin Doyle, a treasury analyst with Dublin-based specialist bank Investec, predicted the ECB would buy up the loans of big private companies.

Will this Stimulate Lending?

Everyone wonders if this will work. Let me ask a different set of questions:

  1. Why should it?
  2. Does the announcement fix any structural problems with the euro?
  3. Does the announcement fix any fiscal issues in any European country?
  4. Does the announcement fix any competitive disadvantages of France vs. Germany?
  5. Does this provide any impetus for structural reforms in France or Italy?
  6. If -0.1% rates for funds parked with the ECB did not stimulate lending, why should -0.2% rates?

Yield Down

  • The yield on the Spanish 10-Year bond is now 2.16%, down from 4.51% a year ago.
  • The yield on the Italian 10-year bond is now 2.35%, down from 4.42% a year ago.
  • The Yield on the Portuguese 10-year bond is now 3.15%, down from 6.77% a year ago.

Meanwhile, yield of the US 10-Year treasury is 2.45%. Apparently there is 0% risk of a restructuring of Spanish, Italian, or Portuguese bonds.

Greece was a one-time event, until Cyprus came along. Then it became a two-time event. But don't worry, it will never happen again.

Anyone really believe that?

Draghi Creates Bond Bubble

All Drahghi really accomplished with LTRO is to make Europe the biggest bond bubble in the world.

Well bubbles can always get bigger, until they pop.

Meanwhile none of these can-kicking efforts have fixed a single structural problem. Instead, they made it easy for governments to delay needed reforms.

Forcing Banks to Lend a Huge Mistake

These attempts to force banks to lend is a huge mistake. Banks lend if and only if ...

  1. Banks are not capital impaired
  2. Banks believe they have credit-worthy borrowers
  3. Credit-worthy borrowers want credit

If banks lend in other circumstances, they will incur losses. They also incur losses if they believe they have credit-worthy customers but they don't.

The problem should be obvious. European banks lack credit-worthy borrowers who want loans, or the banks are capital impaired.

I suggest both.

And if this move by Draghi does spur more lending to small uncreditworthy businesses, the ECB will have done nothing but compound Eurozone problems greatly.

Note: The original title of this post was ECB's €40 bn Stimulus Gamble: ECB Pulls Out Bazooka, Cuts Rates, Buys Assets; Will this Stimulate Lending?

Mario Draghi is actually willing to commit €1 Trillion as explained in ECB Now a Hedge Fund; €1T Bazooka; ECB Promotes Euro Carry Trade; Draghi Has it Backwards.

Mike "Mish" Shedlock

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