Today is the morning after the night before for the European Central Bank which yesterday made a move I forecast some time ago. It was back on the 2nd of September 2011 that I posed these questions.
Negative interest rates have failed to halt the rise of the Swiss Franc but will they spread to us anyway?
Will negative interest rates spread world wide?
In the meantime it became ever plainer that of the major central banks, the ECB was the most likely to take this step with an occasional hint from Japan. The Swiss situation was different in that it saw negative interest-rates for some of its bond yields and also on some retail bank accounts, whereas the ECB is for now imposing it essentially on banks which deposit with it. However there are clear similarities.
The exchange rate
There are clear parallels here and Mario Draghi and his colleagues on the ECB Governing Council must have been very disappointed when the Euro’s decline after their various announcements yesterday was so short. When I pointed this out on twitter the economist Edward Hugh replied that it lasted one hour and fifty-seven minutes only. As I type this the Euro is back in the mid 1.36s versus the US Dollar which is pretty much unchanged on yesterday morning. So the experience here is very similar to that of the Swiss Franc where neither falling nor negative interest-rates helped to weaken the currency very little if at all.
As the exchange rate is perhaps the most powerful monetary tool available these days then if this experience continues we are already downgrading the possible economic impact of yesterday’s moves. As I pointed out on Tuesday we should not be surprised by this as we had already seen 4% of interest-rate reductions before yesterday’s additional 0.1%.
Whilst currencies do not always follow a path you might expect from their countries trade figures some do. This morning has seen yet another current account surplus announced for the Euro area which totalled 18.8 billion Euros in March. In fact this is nothing new and all three parts (trade, services, income account) were in surplus. So the value of the Euro will be supported by this which is happening month after month.
These surged across Europe with particular headlines being created by the fact that the German Dax pushed though 10,000 for the first time. Some of the eu(ro)phoria waned but stock markets are higher overall. Those who think that this is the main aim of central banks these days will no doubt be having a wry smile right now. As to the economic effects of this on the real economy we have discovered to our cost that they are very weak.
These surged too in response to the news. The “core” market which is of course the German Bund saw rallies and its ten-year yield is now only 1.38%. The two-year yield has fallen to 0.03% and may yet venture again into the world of negative yields itself. The periphery saw gains too with the Spanish ten-year yield for example dropping to a record 2.76% this morning. It is now only 0.1% higher than the equivalent UK Gilt and that relationship or spread has come in massively over the past 12/18 months.
So if this continues there will be gains for many Euro nations in that they will be able to issue their debt more cheaply.
What about the real economy?
I have written many times before about the apparent divorce between the financial and real economies in the credit crunch era. We see that some financial markets have improved but what about the real economy? As the dip into negative interest-rates was mostly a technical one affecting money markets and banks we are left reviewing a 0.1% cut. What next a 0.01% one? Anyway in these times of broken monetary transmission mechanisms the rate cut is unlikely to have anything other than a minor effect which I am not absolutely sure will be positive. So let us examine the other measures which come under the category of extraordinary monetary measures. After all we are at this point let rather short of the “everything it takes” promise by Mario Draghi back in 2012 especially as he clearly said at one point this was as far as the ECB was willing to go on interest-rates. That may well be an outright falsehood but he was quite clear about it in the press conference.
This to my mind was initially rather awkward as whilst the use of targeted was no doubt meant to sound impressive it also suggested that the previous 2 LTROs were not targeted. Ooops!As some 1.018 billion Euros of liquidity was provided by them there is an implication here that they could have been better designed. Also the total size of the new effort was estimated at a smaller 400 billion Euros.
Counterparties will be entitled to an initial TLTRO borrowing allowance (initial allowance) equal to 7% of the total amount of their loans to the euro area non-financial private sector, excluding loans to households for house purchase, outstanding on 30 April 2014. In two successive TLTROs to be conducted in September and December 2014, counterparties will be able to borrow an amount that cumulatively does not exceed this initial allowance.
The interest rate on the TLTROs will be fixed over the life of each operation at the rate on the Eurosystem’s main refinancing operations (MROs) prevailing at the time of take-up, plus a fixed spread of 10 basis points.
So they specifically exclude the housing market and would currently cost 0.25% per annum. At this point if you consider imitation to be the sincerest form of flattery than the Bank of England should be very flattered right now as it observes the similarities to its Funding for Lending Scheme. However that similarity also poses its own problem as it has so far failed to do much about lending to small businesses in the UK and continued to fall. Defenders of the policy have been reduced to using that old chestnut the counterfactual by saying the situation would have been worse without it. That is conveniently unproveable of course.
Also the areas that really need help from this seem the least likely to use it as places like Italy have plenty of bad debts for example which have been hindering lending. So there is no clear cut gain here either.
Securities Markets Programme
The SMP is the place where the ECB holds the peripheral debt bought at the height of the crisis. Each week it issues debt itself to suck up the liquidity it provided from this. It calls this “sterilisation” but I do not believe that it is. Going forwards that will matter less as it will stop the sterilisation, although to some extent this is only acknowledging reality as in recent weeks it has struggled to cover the full amount. So around 164.5 billion Euros of extra liquidity will be around in the short-dated money markets. So helpful for them but probably not that much help for the real economy.
Asset Backed Securities
This section was rather like the bit in the film Field of Dreams where we are told “build it and they will come”. Mario Draghi would like markets to create an ABS market so that the ECB can buy some of it. I know that this sounds like a spoof as so much does these days but it is true! Imagine the potential hazards and traps awaiting the ECB as it steps into a pack of wolves and buys “AAA-rated securities”. What could go wrong?
An example of how this could go wrong was illustrated by the way that what was supposed to be top quality paper (debt) deposited at the Bank of England was called “phantom securities” by the Bank when it acknowledged reality. Mario Draghi seems to be almost asking for this to happen again. Is this the way that Europe’s banks finally get rid of their bad debts?
It was only on Tuesday that I asked the question is the ECB’s monetary policy “maxxed-out” and in many ways yesterday it confirmed that if it is not, it is very near to it. Of course all central banks are presently facing up to the reality that their policies have diminishing marginal returns but this is particularly an issue for the ECB as they did not work that well in the first place! Also whilst the talk is of expansion there has been a by now familiar contraction this morning already.
Accordingly, on 11 June 2014 EUR 9664.00 million will be repaid in the tender 20110149 by 8 counterparties and EUR 924.00 million in the tender 20120034 by 4 counterparties.
As The Whispers put it.
And the beat goes on
Just like my love everlasting
And the beat goes on
Still moving strong on and on
It would be remiss of me not to mention the 70th anniversary of the D-Day landings when men like my grandfather mustered such courage as they could and stormed ashore. Happy 70th anniversary to those who survive.