The European Central Bank cut interest rates and will start buying assets, in a bid to boost the flow of funding for the euro-area economy while stopping short of broad-based quantitative easing.
ECB President Mario Draghi’s plan to buy asset-backed securities and covered bonds pushed the euro below $1.30 for the first time since July 2013 as he said the inflation outlook had worsened. Germany’s Jens Weidmann opposed the rate cut and ABS plan, according to two officials.
The ECB “will purchase a broad portfolio of simple and transparent securities,” Draghi said at a press conference in Frankfurt today. “Some of our council were in favor of doing more than presented.”
In committing cash to the market for asset-backed securities, Draghi is making good on his pledge to rekindle an asset class that can funnel loans to the real economy. Even so, it probably doesn’t represent the kind of large-scale bond purchases that some economists say are needed to stave off deflation.
“The ECB stepped up to the plate, again,” said Christian Schulz, senior economist at Berenberg Bank in London. “One way of reading the ECB rate cut is that, due to continued serious resistance against sovereign-bond purchases, the ECB has decided to first exhaust all other options.”
Europe's QE Quandary
Euro-area inflation languished at 0.3 percent last month, far below the ECB’s 2 percent target. The ECB today cut its macroeconomic forecasts for this year from its previous assessment in June.
Gross domestic product is now predicted to expand by 0.9 percent this year and 1.6 percent in 2015, instead of the previous 1 percent and 1.7 percent. Inflation is seen at 0.6 percent this year instead of 0.7 percent previously. The inflation outlook for 2015 is unchanged at 1.1 percent.
“We took into account the overall subdued outlook for inflation, the weakening in the growth momentum in the recent past,” Draghi said. “The Governing Council sees the risks around the economic outlook on the downside.”
The ECB earlier reduced all three of its main interest rates by 10 basis points. The benchmark rate was lowered to 0.05 percent, the deposit rate is now minus 0.2 percent, and the marginal lending facility is 0.3 percent.
The euro fell to as low as $1.2952 and traded at $1.2932 at 5:50 p.m. Frankfurt time.
The dissent from Bundesbank President Weidmann highlights the resistance in Germany, the region’s largest economy. In July, he called ABS purchases “problematic” and warned against supporting bank profits while socializing the losses.
The officials who confirmed Weidmann’s opposition today asked not to be identified because the discussions are private, and a Bundesbank spokesman declined to comment. Draghi said he secured a “comfortable majority” for the decisions.
The ECB President finds himself pressed into action for the second time in four monetary-policy meetings. The 18-nation euro area is struggling with a stalling economy and escalating sanctions against Russia that threaten trade flows.
In June, the ECB cut rates and announced a three-year targeted loan program for banks, called TLTRO, aimed at boosting lending to households and businesses. Draghi said at the time that interest rates were “for all the practical purposes” at the lower bound.
Today he said the central bank is now done with conventional rate cuts. The ECB wants to “make sure there’s no misunderstandings on whether we’ve reached the lower bound,” he said. “Now we are at the lower bound.”
He said details of the ABS program will be announced after the October rate-setting meeting. The securities are backed by underlying instruments such as mortgages or credit-card debt, and are packaged into products containing slices with different risk profiles. Draghi said on Aug. 7 this process in the future has to be “simple, transparent and real,” and not “a sausage full of derivatives.”
The European Commission is considering allowing banks to hold a wider range of asset-backed securities to meet liquidity requirements than foreseen by global regulators, according to an EU document obtained by Bloomberg News. Banks will be allowed to use securitizations backed by assets from car loans to small business and consumer debt under the EU rule, whereas the Basel Committee on Banking Supervision sought to limit securitizations to those backed by residential mortgage debt.
“Today’s measures are predominantly oriented to credit easing,” Draghi said, adding that initially the central bank is targeting the least-risky segment of these assets. Only if governments present a guarantee would the ECB consider buying lower tranches, such as the so-called mezzanine.
The ECB is also restarting its involvement in the covered-bond market. It ended its previous plan in 2012 as demand for the securities recovered.
Issuance of ABS instruments collapsed in the wake of the financial crisis, when they were blamed for being a non-transparent way of transferring risk to investors who didn’t know what they were buying. JPMorgan Chase & Co. estimates that the market has shrunk by more than 40 percent since 2010.
“We want to make sure that these ABS are being used to extend credit to the real economy,” Draghi said. On the size of the program he said that “we’d love to give a figure, for communication purposes. At this stage it’s very difficult.”
He did say that the aim of all the ECB measures combined is to return the central bank’s balance sheet to the level of the start of 2012. The ECB had about 2.7 trillion euros of assets in January 2012, compared with 2 trillion euros now.
There are further hurdles to clear for officials wanting a decisive restart in the ABS market, including a thicket of regulatory initiatives from Basel to Brussels. European Union and international standard-setters are working on as many as 19 measures that could affect demand for ABS, including a standard definition for what constitutes a high-quality securitized product.
Draghi also reiterated that monetary easing must be combined with structural reforms. Countries including France and Italy have pushed for greater flexibility within EU fiscal rules.
“There’s no fiscal or monetary stimulus that will produce any effect without ambitious and important and strong structural reforms,” the ECB president said, reprising comments from his speech last month at a symposium for central bankers in Jackson Hole, Wyoming.
“In many parts of the euro area there are several reasons that growth is not coming back, but one is lack of confidence,” he said. “Most if not all the data we got in August, both hard and soft, on GDP and inflation, showed that the recovery was losing momentum.”
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