The European Central Bank took markets by surprise by delivering a series of stimulus measures at today’s policy meeting. While the majority of economists were expecting a 10bps cut in the deposit rate and some form of modification to the asset purchase program, the ECB went further and reduced its three key interest rates, as well as increase the size of its bond purchases.
At today’s announcement, the ECB cut its main refinancing rate from 0.05% to 0.00%, a move that was not expected by analysts. It also decided to lower its marginal lending facility from 0.30% to 0.25%, and as expected, reduced the deposit rate by a further 10bps to -0.40%.
What pleased the markets more though was an increase to the size of its monthly asset purchases from €60 billion to €80 billion a month. This is the first increase in the size of the program since it was launched in January 2015. A further surprise came from the announcement that the ECB will start to include investment grade euro-denominated bonds issued by non-bank corporations to its list of asset purchases, thereby expanding the bond buying scheme beyond the public sector.
In addition to the above measures, the ECB decided to introduce a new series of longer-term refinancing operations, called TLTRO II, with a maturity of four years. This is aimed at encouraging bank lending across the euro area.
The euro plunged 1.4% after the decision, dropping from around 1.0980 to 1.0821 dollars. However, it soon rebounded sharply, soaring to a 3-week high of 1.1144 dollars in late European session.
At the press conference that followed the announcement, ECB President Mario Draghi pointed to the weaker than expected demand and inflation across the Eurozone for increasing the urgency for more action. The ECB lowered its Eurozone growth forecasts for 2016 and 2017 to 1.4% and 1.7% respectively. Inflation forecasts were also cut and will average 0.1% in 2016 and 1.3% in 2017.
Draghi said negative inflation is “unavoidable” over the next few months due to the fall in oil prices. He stressed it was therefore important to ensure that deflation does not become “entrenched in second-round effects on wages and price-setting” and that inflation returns to the 2% target level without “undue delay”.
In a sign that the current low interest rate environment isn’t about to end anytime soon, Draghi strongly signalled that rates in the Eurozone will stay “very low, for a very long time, well past the horizon of our operations”.
European equity markets were boosted by the ECB’s plethora of monetary easing measures. The Frankfurt Dax jumped by 2.8% and the Paris Cac 40 by 3.5%. But both indices fell back in late trading to stand less than 1% higher as the effects of the ECB’s surprise wore off.
Further easing such as cuts to the interest rates cannot be ruled out in the coming months if inflation does not show any signs of moving towards the Bank’s 2% target. But further increases to the size of the asset purchase program remain doubtful as it would risk upsetting the Governing Council’s hawks such as the Bundesbank’s Jens Weidmann, who was not part of today’s rotating vote. It should be interesting to watch whether today’s actions prove sufficient in reviving growth and inflation in the Eurozone.
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