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    ECB Promise Sinks Euro

    After two years of limited success with its expansive monetary policy, the European Central Bank has attempted to head off the latest threat to economic recovery by promising to take measures if financial market turbulence blocks transmission of stimulus to the real economy. 

    "In the light of the recent financial turmoil, we will analyze the state of transmission of our monetary impulses by the financial system and in particular by banks,” noted ECB President Draghi to European Parliament in Brussels on Monday.

     Mr. Draghi was responding to the collapse in equity values for many European banks in the recent stock sell-off. This could put constraints on the ability of lenders to increase their loan book.

    If the continent's banks are unable to offer more funds to the market any increase in liquidity by the central bank could die a slow death locked in the deposit accounts of the ECB itself. The ECB's negative deposit rates have not encouraged its member banks to lend excess reserves rather than keep them on deposit at the central bank, despite the charge assessed by the bank. 

    The euro promptly fell over a figure against the dollar after Mr. Draghi's comments as the currency market showed a very different opinion from its reactions to Mr. Draghi's prior verbal attempts to bolster the ECB's monetary policy. 

    Mr. Draghi said that though the ECB would "not buy" bad loans from Italian banks it would let the banks use these loans as collateral at the central bank. This would remove the non-performing paper from the banks' books reducing the amount of reserves held in static against them and permitting the banks to expand their loan portfolio.

    Though Mr. Draghi stressed the ECB would not be buying the loans the result would be much the same.  Mr. Draghi also said that there will be no differential treatment of bad loans throughout the Eurozone.

    Does the ECB truly intend to scour the continent's banks system of bad loans? That would be a policy far beyond the Federal Reserve's targeted asset acquisitions. If true the falloff the euro has just begun.

     

    Joseph Trevisani

    Chief Market Strategist

    WorldWideMarkets

    Chart: Bloomberg

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