Analysis of ECB Action 10/03/2016

by George Hatjoullis

There was two constructive actions. First, four targeted long-term finance operations which could, in the right circumstances, be effected at the Deposit Rate of -0.4%. This goes some way to addressing the margin impact of negative deposit rates on banks. Second, the inclusion of investment grade non-bank corporate debt in the list of eligible assets for QE. This will allow banks to re-package loans into investment grade debt and include them in the list (one presumes). Both help banks and this is what is required in the eurozone. The rest was pointless and arguably counter productive.

The premise of the rate cuts is that real interest rates are too high and this is choking off real economic activity. Really? Investment decisions are waiting on a few a basis points here or there on loan rates? I don’t think so. The key to investment decisions is risk. If you fear losing your whole investment then a few basis points on funding is not going to influence your decision. The purpose of the package should have been to reduce the perceived risk of future real investment. This is not easy for monetary policy as it is not explicitly designed to do this. I do not think this set of actions took us any closer.

The missing ingredient is effective demand and this is noticeable by its absence (everywhere). It may be cheaper to borrow to spend but do people feel confident that they will be able to repay? Moreover, do banks feel the people will be able to repay. Banks now have an enhanced duty of care not to lend recklessly. The only agency that can spend with impunity is the state. However, even this entity is now constrained by self imposed ideological borrowing limits. It could of course use money printed by the Central Bank but that is taboo. The irony is it is taboo because it is inflationary which is precisely what we want to boost…inflation.

The QE removes risk free assets from an economic system crying out for risk free assets. How does this help? I believe the logic is that faced with lending the cash to banks in the form of uninsured (therefore risky) deposits people will invest in even riskier equities or business ventures. In practice, people hang on to their risky assets which just get more expensive or offer a lower interest rate. The reason is they do not feel inclined to take risk and nothing that the CB can do will change this. I have said exactly all of this before using different jargon. I hope it is clear now.