The ECB delivered a comprehensive policy package, with attention now turning to the Fed meeting
At its meeting on September 12th, the ECB: i) lowered its policy rate, introducing a two-tier system for remunerating excess liquidity holdings; ii) modified favourably the terms of TLTRO3; iii) reinstated net asset purchases; and iv) amplified its forward guidance vis-à-vis rates and QE. At the same time, the ECB acknowledged the limits of (its) monetary policy to revamp growth and inflation, urging European policymakers to step up fiscal policy (see Quotes of the week on page 3). Bund yields rose significantly during the course of the meeting (by c. 10 bps), while the EUR ended the session higher (see graphs and commentary on page 3).
Specifically, the ECB lowered the Deposit Facility Rate (DFR) by 10 bps to -0.50%, while the rate for Main Refinancing Operations (MRO) was unchanged at 0.0%. The decrease in the DFR was accompanied by measures to mitigate the negative effects on financial institutions’ balance sheets by the sub-zero interest rates and to avoid unwarranted repercussions for bank lending growth. The healthy pace of lending, currently at a 10-year high of 3.6% yoy, remains a crucial supporting factor for the bank-based euro area economy. A two-tier system was introduced for euro area banks’ excess reserves held in the ECB. Circa €0.8trillion out of €1.8trillion will be remunerated at 0.0% instead of -0.5%, providing net income relief of circa €2-3bn per annum or 2.5% of euro area banks net income as of end-2018.
At the same time, the ECB improved the conditions of the Targeted Longer-Term Refinancing Operations (TLTRO3) extending the maturity of TLTRO3s by one year to three years (TLTRO2s are circa €690bn or 3% of euro area banks’ liabilities as of early September), introducing a repayment option after two years. In addition, the ECB reduced the interest rate on TLTRO3 by 10bps.
Furthermore, the ECB will restart as of November the net asset purchases under its Asset Purchase Programme (€2.65 trillion have been accumulated so far under APP) at a monthly pace of €20bn. To extend the pool of eligible assets, both public and private sector assets (the latter contrary to the previous APP terms) with yield-to-maturity below the DFR will be eligible to participate. Importantly, the new APP will run until the ECB starts raising its key interest rates; a quasi-open-ended QE, as scarcity constraints of the available pool of assets (e.g. German Bunds or Netherlands Bonds) could resurface in the distant future (> 2 years) as the issuer/issue limit of 33% remains.
The ECB also switched from time-dependent to state-dependent forward guidance. It now expects to keep interest rates at their present or lower levels until its inflation outlook converges “robustly” to its symmetric target of close to, but below, 2% within its projection horizon, “and such convergence is consistently reflected in underlying inflation dynamics”. The specific calendar reference “at least through the first half of 2020” was removed. Essentially, that wording should precondition a close to 3-year ahead projection of 1.9% for both CPI and core CPI inflation.
Recall that the latest ECB staff projections remain well below these levels, with the estimate for both measures at 1.5% yoy in 2021, down 0.1 pp compared with the June projections. Apart from inflation, GDP growth projections were also revised down, by 0.1 pp to 1.1% yoy for 2019 and by 0.2 pps to 1.2% in 2020 (steady at 1.4% for 2021).