Draghi’s Richer Toolbox Keeps ECB Calm as Turkey and Italy Rage
(Bloomberg) -- Turkey’s currency crisis, Italy’s bond woes and U.S. President Donald Trump’s protectionism are focusing minds on whether the European Central Bank needs to act to safeguard the euro-area economy.
Policy makers have been quiet through the summer break, after saying at July’s meeting that global uncertainties are “prominent” while sticking to their plan to rein in stimulus. Like the U.S. Federal Reserve, the ECB is betting domestic growth is solid enough to prevent contagion from trouble spots.
Still, President Mario Draghi also said years of crisis-fighting mean he’s now leading a “different central bank” with a “much, much richer set of monetary-policy tools.” Here’s a look at what they are, should they be needed:
The ECB’s Governing Council “anticipates” slowing its flagship bond-buying program in October and capping holdings at the end of the year, when they’ll reach 2.6 trillion euros ($3 trillion). That plan is subject to incoming data, leaving room to extend purchases if needed.
Such a move isn’t without hurdles. It could require looser purchasing rules to overcome scarcity in some markets, and would likely stoke discontent in countries such as Germany that have criticized quantitative easing.
“The ECB have been quite transparent that they have a more limited room for maneuver,” said Anatoli Annenkov, senior economist at Societe Generale SA in London. “But I don’t think that would prevent them from doing anything.”
The central bank already pledges to maintain its holdings by reinvesting maturing debt for “as long as necessary,” leaving little room to be more expansive on that score.
The standard central-bank response to economic woes -- cutting interest rates -- looks far-fetched for the ECB, according to Claus Vistesen, chief euro-zone economist at Pantheon Macroeconomics Ltd in Newcastle, U.K. The Governing Council expects to keep rates at record lows “at least through the summer of 2019” and hasn’t pushed back against expectations that the next move will be an increase.
“The ECB would extend QE further before going for a rate cut,” Vistesen said. “But the fact is that the ECB is a bit of a supertanker. They’ve already changed course toward the exit and it’s going to take a lot for them to go back now.”
One area where Turkey is fraying nerves is the exposure of euro-zone banks, such as Spain’s Banco Bilbao Vizcaya Argentaria SA and Italy’s UniCredit SpA. If those concerns push up lenders’ funding costs too much, policy makers have a measure that might help.
The ECB started issuing cheap long-term loans to banks in the wake of the global financial crisis, and honed the tool after the euro zone’s sovereign-debt crunch. Early versions simply locked in funding for months or years, while recent iterations were designed to make banks use the cash to lend to the real economy rather than loading up on government bonds.
“The ECB has used it in the past when it comes to stabilizing financial markets,” said Annenkov. “If you have a lot of concerns on credit risk, liquidity issues, that could be fairly useful.”
Still, there’s no sign of contagion yet, and in any case the euro zone has 1.9 trillion euros in excess liquidity.
For more than a decade, the ECB has lent banks as much cash as they want, provided they can stump up the collateral. That system, known as fixed-rate full-allotment, will stay in place “as long as necessary.”
Solvent firms facing a temporary squeeze can also turn to their national central bank for Emergency Liquidity Assistance, with lighter collateral rules but a higher cost. ELA has kept Greek lenders afloat since 2015 when the country almost fell out of the currency union.
Another legacy of the global financial crisis is a set of agreements allowing the ECB to get currency from other central banks, to prevent commercial lenders from being unable to meet foreign-exchange commitments. The arrangements currently cover U.S. dollars, British pounds, Swiss francs, Canadian dollars, Swedish krona, Danish krone, and Chinese yuan.
What the ECB hasn’t done is to set up swap lines with small central banks outside the European Union, and economists say it’s unlikely to make an exception for Turkey.
“We find it very hard to see why the ECB would go down this route,” said Krishna Guha, vice chairman at Evercore ISI in Washington. “The ECB has traditionally been still more careful than the Fed in extending swaps to smaller economies that operate in its shadow.”