ECB Comes Out Swinging, Shifts Forward Guidance On Rates, Announces New TLTRO

You could say that the bar for a dovish surprise from the ECB on Thursday is high, especially in light of Wednesday’s “leak”.

As a reminder, we’re all set to see a downgrade of the economic forecasts sufficient to justify a new round of TLTROs. Both the inflation and growth outlook are set to be cut, providing a “monetary policy justification” for a decision to at least lay the groundwork for more loans.

The euro-area is on the frontlines of the global growth slowdown and with everyone from the Fed to the BoC to the RBA leaning dovish, and with the BoJ having recently suggested that the deployment of more easing measures is possible, there’s zero doubt that the ECB will join in taking steps to boost accommodation just two months after ending net asset purchases.

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No Country For Old Hawks.

When it comes to delivering a “dovish surprise”, it’s never really about that for Draghi. Rather, it’s always about threading the proverbial needle, where that means doing enough to deliver on market expectations while simultaneously projecting an air of infallibility and control that frustrates doubters and makes skeptics question whether up can be down, whether black can be white.

At some point, the forward guidance on rates will have to be adjusted. The “at least through summer of 2019” language will be stale soon and as far as the market is concerned, it’s well past its expiration date. Expectations for the first hike have been pushed into 2020.

(BofAML)

Draghi’s penchant for pulling rabbits out of hats notwithstanding, there are pressing questions about whether the ECB has missed its window (permanently) setting Europe on the path to becoming Japan.

“In our latest credit survey, we noted plenty of references to ‘Europe is Japan’ given how quickly the ECB appears to have altered its tune [and] while such a debate is clearly more complex, the comments, we think, are nonetheless prescient as 20yrs ago to the month (Feb 12th ‘99) the BoJ first cut interest rates to zero”, BofAML’s Barnaby Martin wrote last month before reminding you that “with the exception of a few years in between, Japanese interest rates have barely moved since.”

And while history may not repeat itself, it does often “rhyme”. To illustrate, Martin used the following chart which “shows that the progression of Japanese and ECB interest rates has been eerily similar when overlapping the two time series to match the point of zero interest rates (ECB deposit rates fell to zero in July ’12).”

(BofAML)

The disconcerting read-through from Martin:

A crude extrapolation of chart 1 implies that ECB deposit rates will still be broadly at today’s levels in 2033!

He went on to say that extrapolating from that chart suggests the ECB will probably make a policy error towards the end of this year by trying to raise rates, only to be forced to cut them again. That too would be consistent with the Japanese experience, he cautioned.

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It’s ‘Eerie’: One Bank Asks Whether Europe Is Now Japan

As far as Thursday’s meeting goes, there’s consensus on the Street that something needs to be done soon, although opinions on the exact timing of the TLTRO announcement (i.e., when it will be tipped versus when the details will be unveiled) vary.

“The ECB does need to ensure that the weakness in foreign trade does not feed back to domestic demand [and] given prospective bank funding needs in Spain and Italy, there is a strong case for the ECB to launch another round of Long Term Refinancing Operations (LTROs) and prevent tighter credit conditions, but we expect the ECB to wait another month or so before announcing that”, Credit Suisse wrote earlier this week, adding that “the ECB may also be tempted to partly validate market expectations and change their forward guidance on policy rates from a commitment not to raise them ‘through the summer of 2019’ to a later date, possibly early 2020.”

For Credit Suisse, that would be a mistake. “Analysis suggests that the ECB’s negative interest policy — in effect for almost five years — is having a pernicious effect on the banking sector’s capacity to extend credit to the real economy”, they go on to write.

After warning that euro-area bank lending to firms is rolling over, Credit Suisse goes on to note that “much of the recent slowdown in credit growth can be attributed to Italy and Spain [and] it may be that the prospect of tougher financing later this year is inhibiting their willingness to lend.”

(Credit Suisse)

Last week, Barclays cautioned that “while the aggregate level of liquidity in the system is abundant, this aggregate level of liquidity surplus should not be considered a reliable indicator of effective liquidity conditions for the euro system banks in each country, which could be far less accommodative than signaled by the level of the surplus”.

Specifically, the bank noted on Friday that “the cross-border transfer of liquidity within the euro area remains very limited.” Have a look at the following two charts which illustrate that latter point rather poignantly.

(Barclays)

For their part, Goldman also expected the ECB to announce a new TLTRO this week, “although details could follow later and indicate that it could adjust its guidance if risks to the outlook materialize.”

When it comes to NIRP and its pernicious effects on banks, BofAML had a bit more to say about this in another update ahead of the ECB. Consider the following:

A big focus in the last meeting was negative rates and their impact on bank profitability. Draghi has long argued that the adverse impact on banks’ Interest margins is more than offset by the positive effect of rising lending volumes. On this, Wednesday’s M3 data will not have helped the ECB. Flows of loans to the corporate sector fell from +€9.4bn in December to -€0.8bn in January, the first negative print since June 2017. Even more worrying is our economists’ ‘Credit Impulse’ indicator, which fell to its lowest level since 2013.

If you want to know what NIRP does to the market’s expectations for bank profitability, look no further than the following chart:

(Credit Suisse)

“[That] shows that banks’ equity prices respond positively to policy rate cuts when those rates are positive, and especially so in stressed conditions such as the financial crisis, but the impact of cuts when rates are below zero is both negative and greater”, Credit Suisse warns, in the same note cited above.

Now cue the tiering discussion.

In any case, there’s a lot for the ECB to ponder right now – to say this is a “critical juncture” would be an understatement. Clearly, political risks in Europe around the EU elections only increase the urgency, as does lingering uncertainty around Brexit. As far as the “ammo” question is concerned, consider this bit of foreboding color from BNP:

Our analysis suggests that while the ECB still has some ammunition left, its arsenal lacks ‘easy’, cost-free options. In general, it is worth keeping in mind that the more grave the circumstances, the more determined central banks become and the lower the resistance to the path less travelled — after all, only some years ago few would have thought that the ECB would buy sovereign bonds on a large scale. Still, we cannot escape the sense that the ECB will take its time, running the risk of falling ‘behind the curve’. When the means to respond are no longer unlimited, the bar to act is likely to be higher.

And with that, we have the statement. You can find it below. Suffice to say the ECB looks to have indeed delivered a dovish surprise.

The forward guidance around rates has been changed. Rates are now set to “remain at their present levels at least through the end of 2019.” That, in keeping with the tweak to the reinvestment language in December, means the reinvestment period has been mechanically pushed out (i.e., “past the date when it starts raising the key ECB interest rates).

And most important, a new round of TLTROs has been announced. The start date and some of the operational details are already out.

This, folks, should make for an interesting press conference.

At today’s meeting the Governing Council of the European Central Bank (ECB) took the following monetary policy decisions:

(1) The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively. The Governing Council now expects the key ECB interest rates to remain at their present levels at least through the end of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

(2) The Governing Council intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

(3) A new series of quarterly targeted longer-term refinancing operations (TLTRO-III) will be launched, starting in September 2019 and ending in March 2021, each with a maturity of two years. These new operations will help to preserve favourable bank lending conditions and the smooth transmission of monetary policy. Under TLTRO-III, counterparties will be entitled to borrow up to 30% of the stock of eligible loans as at 28 February 2019 at a rate indexed to the interest rate on the main refinancing operations over the life of each operation. Like the outstanding TLTRO programme, TLTRO-III will feature built-in incentives for credit conditions to remain favourable. Further details on the precise terms of TLTRO-III will be communicated in due course.

(4) The Eurosystem’s lending operations will continue to be conducted as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the reserve maintenance period starting in March 2021.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 14:30 CET today.