ECB moves highlight stark economic realities
Last week, the ECB took the latest step in delivering on that promise.
It cut its official lending rate from 0.25% to 0.15%; it cut the rate of interest that it pays commercial banks who place excess reserves and deposits with it to a negative 0.1% and it announced that it will conduct targeted longer-term refinancing operations (LTROs).
It also announced that it is preparing a programme to buy asset-backed securities in order to increase liquidity in the banking system. This is a variation on quantitative easing.
The cut in its main refinancing or lending rate and the move to negative deposit rates are not very significant in terms of their impact, but symbolically they send out a clear message that the ECB remains committed to doing whatever it takes.
The cut in the lending rate is, in theory, intended to be passed on to borrowers by the banks, but here in Ireland the only borrowers that are likely to benefit are those lucky souls with tracker mortgages.
For borrowers on variable rates, the reality is that they will continue to subsidise the loss-making tracker mortgages. The move to negative deposit rates is intended to discourage the banks from holding excess deposits and reserves, and instead lend the money into the real economy.
It is also far from clear how effective this will really be. The targeted LTROs are somewhat more interesting. In June, September and December this year the banks will be able to borrow a sum equivalent to up to 7% of their outstanding non-mortgage lending to the non-financial private sector. Then, in quarterly operations up to June 2016, the banks will be able to borrow additional amounts of up to three times the net new lending provided between April 2014 and the allotment date. All LTROs will mature in September 2018 and will be offered at 10 basis points over the ECB’s main lending rate. Cheap funding for the banks, but it is contingent on actual lending.
The whole effort is intended to make it cheaper for banks to lend money into the real economy. It remains to be seen how it will work, but the ECB clearly believes it is necessary to take these sorts of drastic actions and the evidence certainly supports this belief.
In the economic forecasts accompanying the policy announcements last week, the ECB forecast GDP growth of 1% this year, 1.7% in 2015 and 1.8% in 2018. Inflation is projected at 0.7% this year, 1.1% in 2015 and 1.4% in 2016. It is currently running at just 0.5%.
These actions, and the accompanying forecasts, paint a picture of an economy that is struggling to get off the ground and where inflationary pressures are subdued.
The ECB does not believe the area will descend into a deflationary spiral with falling prices, but it is starting to take out insurance to ensure this will occur.
Across the eurozone, borrowers can rest assured that the official interest rate environment will remain at historically low levels. This will continue to benefit tracker mortgages here, but variable rate borrowers may not be as lucky.
Unemployment in the eurozone stands at an elevated rate of 11.8%. In marked contrast, data this week showed that employment in the UK increased by 345,000 over the three months to April, which is the strongest quarterly increase since records began in 1971. The unemployment rate has fallen to 6.6%. Furthermore, the UK economy was the fastest growing in the EU last year, and is likely to be the same this year and next. For a country that was promised disease and pestilence if it remained outside of the ‘great’ EMU project, it is managing to survive surprisingly well.
