ECB Cuts Rates, Revives QE to Lift Growth as Draghi Era Ends
The European Central Bank cut interest rates further below zero and revived bond purchases after President Mario Draghi overcame critics of his stimulus policies to make a final run at reflating the euro-area economy.
The ECB reduced the deposit rate to minus 0.5% from minus 0.4%, and said it’ll buy debt from Nov. 1 at a pace of 20 billion euros ($22 billion) a month for as long as necessary to hit its inflation goal.
“We have headroom to keep going on for some time at this rhythm,” Draghi, whose eight-year term ends next month, said at his press conference in Frankfurt. “We still think the probability of recession for the euro area is small, but it’s gone up.”
The ECB also cut the cost of its long-term loans to banks, and lenders will get an exemption from negative rates for some of their deposits after an outcry from the industry about the squeeze on profitability.
After initially rallying on the news, European government bonds’ enthusiasm for the measures rapidly faded, with short-term securities in particular coming under pressure due to the limits of the ECB’s rate cuts and bond-buying plans. The euro, having weakened on the headlines, reversed losses, while stocks swung between gains and losses.
The ECB changed its guidance on interest rates to say they’ll stay at present or lower levels until the outlook for inflation “robustly” converges to its goal of just below 2%. It previously expected borrowing costs to stay unchanged until mid-2020. It also scrapped a 10-basis point rate premium previously attached to its long-term loan program.
“Draghi has continued to push the envelope despite the opposition from some Governing Council members to restarting QE,” said Ken Wattret, chief European economist at IHS Markit. “Further easing is likely given the likelihood of more of the same on growth and inflation.”
The actions prompted U.S. President Donald Trump to tweet that the ECB is “acting quickly” while the Federal Reserve “sits, and sits, and sits.” That’s in line with his strategy of calling on the Fed to cut rates aggressively. The Fed is likely to lower borrowing costs next week for the second time this year, as central banks around the world ease to combat the spreading weakness.
Questioned on that tweet, Draghi said “we don’t target exchange rates. Period.”
Following the ECB’s policy decision, the Danish central bank lowered its deposit rate to minus 0.75%, taking it back to an historic low as it seeks to defend the currency peg.
The ECB’s announcement of a new stimulus package is a remarkable turn of events, just nine months after it signaled it was done with ever-looser policy. Now inflation is running at barely half the goal, and the manufacturing sector is in a contraction that risks spreading to the rest of the economy.
Hours before the decision, industrial-production figures showed the third quarter off to a weak start with euro-zone output dropping 0.4% in July, more than expected. The decline was led by Germany, which is on the verge of a recession as a global slowdown in trade caused by the U.S.-China standoff and the uncertainties surrounding Brexit hurts its exporters.
The approval of such broad measures is a win for Draghi in his penultimate meeting. Governors from core economies including Germany and the Netherlands pushed back against the resumption of quantitative easing, saying it should be a last resort in case the outlook worsens.
He acknowledged the “diversity of views” on asset purchases but said that “in the end the consensus was so broad there was no need to take a vote.” He also said there was “no appetite” to raise the self-imposed limits on how much debt the ECB can buy, a key sticking point among critics who see QE as blurring the line between monetary and fiscal policy.
What Bloomberg’s Economists Say...
“The overall ambition of the package is broadly in line with the Bloomberg Economics forecast. Asset purchases are smaller than the 45 billion a month we expected, though the open ended nature -- rather than the 12 months we expected -- and the tie-in to inflation dynamics means it could end up being very substantial.”
-- Jamie Rush and David Powell. See their ECB REACT
Still, there are doubts the ECB’s latest measures will prove as effective as hoped. Longer-term bond yields have already fallen sharply because of the economic slowdown, and another round of debt purchases might not exert much more downward pressure.
Academics have questioned the effectiveness of negative rates, with a recent study published by the University of Bath finding they decreased lending. The fact that the latest rate cut is accompanied by exemptions to soften the impact on banks will fuel those concerns. Lenders say they’re forced to absorb most of the cost of negative rates, a charge on their overnight deposits at the central bank, because they can’t easily be passed onto ordinary customers.
Such doubts over the remaining firepower of central banks have put the spotlight on fiscal stimulus. Draghi and his successor, Christine Lagarde, have both repeatedly called on governments to do more to bolster the economy, and the president suggested that the topic was rare point of harmony on Thursday.
“One thing was unanimous,” he said. “Namely that fiscal policy should become the main instrument.”
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