It is widely expected that the ECB would stand on the sideline in July. Policymakers would take more time to assess the impacts of the stimulus package announced last month. President Draghi would mainly focus on providing more details on the design and expected impact of the measures announced in the June meeting and probably the preparatory work on small scale asset purchases (ABS). However, with the Eurozone’s inflation staying at recession level, policymakers are obliged to take more actions going forward.
Recalling ECB’s action last month, the main refi rate and the deposit were lowered by -10 bps to 0.15% and -0.10% respectively. The rate of the marginal lending facility was down from 0.75% to 0.40%. Besides, the ECB also launched a series of targeted long-term refinancing operations (TLTRO), with all maturing in September 2018. This aimed at maintaining low cost of funding for banks for 4 years while supporting bank lending at a time when credit demand is improving. The main refinancing operations (MRO), a fixed rate full allotment operation, were extended at least until December 2016. The tool is to guard against any liquidity accident and reinforce the forward guidance. On the other hand, the central bank announced to cease sterilizing the liquidity injected from the Securities Markets Program (SMP) which involved the purchase of bonds from troubled “peripheral” Eurozone countries. This would increase the level of excess liquidity, probably to about 250B euro. Meanwhile, the central bank agreed to intensify preparatory work related to outright purchases of asset-backed securities (ABS).
Much of the favorable market reaction after the June meeting has been reversed, with the euro strengthening again, European equities weaken in particular banks and peripheral stocks and peripheral spreads widening again. Meanwhile, inflation has remained low with annual inflation staying at +0.5% m/m in June while core annual inflation, excluding energy, food, alcohol and tobacco, edging higher to +0.8%. The region’s inflation has stayed in the ‘danger zone’ of below +1% as described by President Draghi. It’s also far below the ECB’s medium-term target of just below +2%.
Besides, the ECB’s rate cut has not stimulated peripheral banks to lend more, signaling that the monetary easing is not feeding evenly through to the real economy across the bloc. According to Reuters’ calculation, the daily average turnover in overnight bank-to-bank lending markets since the ECB cut its deposit rate to -0.1% on June 5 was 27.3B euro, mildly above the 26.5B euro billion average for 2014. Banks was reported from having taken 97B euro from the ECB in one-week loans, compared with 115B euro maturing.
While the ECB would stand on the sideline this month, weak inflation and other risks would urge the central bank to step up with further stimulus. It is likely that ABS would be adopted in the next 12 months while large scale QR might be triggered thereafter in order to fight weak inflation.