In the July meeting, the ECB mainly focused on the technical details of the easing measures it announced in the previous month. What the market concerned the most was the constraints that the central bank would impose on banks as they attempt to recycle the proceeds of the TLTRO. President Draghi indicated that there wouldn’t be any constraint of this nature. Draghi also suggested that the aim of lowering the deposit rate into negative territory was to keep the corridor at 25 bps and to avoid any negative repercussions on interbank market volume that could follow any further narrowing. On the preparatory work related to outright purchases of ABS, he noted that a precondition for the ECB to launch such program is a reduction in regulatory capital requirements for financial institutions’ ABS holdings. Moreover, the ECB announced that it would reduce the frequency of its meetings to once every 6 weeks from January 2015 onward and it would publish regular accounts of the policy meetings.
The good news is that the conditions of the TLTROs for banks are not too strict and should be supportive for high participation. For banks that are already increasing their net lending to businesses and households (excluding mortgages), the benchmark will be the average lending in the 12 months to April 2014. This means that simply maintaining their efforts of the last few months will make them eligible to significant additional liquidity beyond their first allotment without any risk of forced early repayment. Banks that are reducing their net lending have to change their behavior as, by April 2015, their benchmark will be equal to their actual lending behavior in the 12 months to April 2014. In this case, these banks will be able to borrow from the ECB any net lending less negative than that. Still, by April 2016, in order not to be forced into early repayment of the entirety of their TLTRO take-up, they will have to show that their total lending since May 2014 exceeds this benchmark. The new operations carry no penalties (except for the reimbursement of the TLTROs liquidity borrowed in September 2016) for banks that miss the lending target.
Concerning the rate cut, especially the lowering of the deposit rate into negative territory, President suggested that this aimed at keeping the corridor at 25 bps and to avoid any negative repercussions on interbank market volume that could follow any further narrowing. Draghi also suggested some occasions where the deposit rate should return to 0%. According to him, the massive increase in the liquidity surplus during large scale QE could push Eonia permanently into negative territory at current rates. In this case, the deposit rate should be adjusted to 0% so as to avoid the negative implication on money market functioning from overnight rates consistently in negative territory.
The ECB decided to leave the interest rates unchanged in July, noting that the rates would stay where they are for an extended period of time. The central bank reiterated the commitment to using unconventional instruments should it become necessary to further address risks of too prolonged a period of low inflation and to safeguard the firm anchoring of inflation expectations over the medium to long term. Yet, the ECB currently sees both upside and downside risks to the outlook for price developments as limited and broadly balanced over the medium term. As we mentioned in the preview, the next step would likely be ABS purchases. Regarding this, the ECB noted that a precondition for the launch of such program. President Draghi indicated that the work on this program is “intensifying” but the central bank should be more comfortable if the regulatory framework on this asset class has changed.
Finally, the ECB announced that it would adjust the schedule of policy meetings to a 6-week beginning in January 2015. The central bank stated that it would publish regular accounts of the policy meeting but the format of these accounts has yet to be confirmed.