Who’d be a central banker? Last December, European Central Bank (ECB) president Mario Draghi was widely criticized for leading markets up the garden path and delivering a lukewarm package of stimulus measures.
The ECB’s latest policy announcement, on March 10, delivered a formidable package of stimulus measures, exceeding investors’ expectations. But in our view, Draghi’s hesitant performance during the subsequent press conference meant he delivered a mixed (indeed, almost hawkish) message, undoing all of the good work. Markets initially responded positively, but quickly reconsidered and retreated.
The key policy changes were a 10 basis point (bp) reduction in the deposit rate to minus 40bp and a €20 billion increase in the pace of the ECB’s monthly asset purchases to €80 billion.
Lower for Longer
This was in line with our expectations but more than priced in by markets. And the ECB Governing Council went further still. Its forward guidance noted that rates would “remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.” What’s more, the central bank cut its refinancing rate by 5bp to zero, added investment-grade corporate bonds to the list of assets it can buy and unveiled four new targeted longer-term refinancing operations (TLTROs).
The last measure was the biggest surprise. It effectively amounts to subsidized loans, because under certain conditions, the interest rate on these loans can be as low as the deposit rate—in other words, negative. This represents an important ECB switch away from the exchange rate channel and towards the bank lending channel.
But while the measures didn’t disappoint, we think the message Draghi delivered in the press conference certainly did. In an effort to address investor concerns about negative rates, Draghi said that the ECB’s experience of the negative rate experiment had, so far, been “very positive” but that it couldn’t assume this would stay the case if rates moved even lower.
He added that the ECB wanted to send a signal that it realizes there’s a limit on how much further it can lower rates and that the Governing Council doesn’t “anticipate” cutting rates further. Not surprisingly, markets interpreted this statement as a sign that we’ve reached the lower bound on the interest rate front.
In our view, these somewhat mixed messages show that the Governing Council shares many of the market’s concerns about negative rates and believes that it’s either at—or close to—the lower bound. But this doesn’t mean it won’t lower rates again.
More Rate Cuts Are Possible
In fact, the ECB’s forward guidance explicitly raises the possibility of further rate cuts and the central bank has already reneged on an earlier commitment not to lower rates further. However, it does mean that future monetary easing is more likely to come through unconventional channels. The “bottom line,” Draghi said, is that “more and more the emphasis will switch from rates instruments to other non-conventional instruments”.
Once the dust has settled and markets get time to focus on what the ECB actually delivered today, we suspect they may start to view its measures in a more positive light. They may also reflect upon the irony of the latest turn of events. After spending several weeks worrying about the adverse side-effects of negative rates, markets have now frowned on the news that the ECB shares these concerns, while still managing to deliver an aggressive easing package.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.