Free Trial

MNI POLICY: ECB Lane Says Depo Rate Cut Option if Need: Blog

MNI (London)
     LONDON (MNI) - The following is the text of a blog by ECB Chief Economist
Philip Lane explain Thursday's policy moves.
     In this blog post, I will explain the analytical framework underlying the
comprehensive package of monetary policy measures that the Governing Council
decided yesterday. The spreading of the coronavirus is a severe economic shock
to the world and euro area economies. In addition to the much-discussed
potential interruption of supply chains, the necessary containment measures that
are being introduced in many countries imply both a temporary decline in
production and the cancellation or postponement of many expenditure plans. In
overall terms, this situation has an immediate adverse impact on the economy.
     In fact, the latest survey data measuring current global activity have
nosedived (see Chart 1). Moreover, as lockdown measures are implemented more
broadly and for a longer duration, a more substantial and longer lasting
downturn is likely. At the same time, success in containing the virus - notably
through an appropriate policy response - will ultimately allow a return to more
normal economic conditions.
     The clear aim for policymakers should be to mitigate the impact of the
shock, by countering pro-cyclical amplification dynamics and muting propagation
forces that might convert a temporary shock into a decline in long-run economic
performance. For governments, in addition to meeting the immediate public health
challenges that are needed in order to containing the spread of the coronavirus,
an ambitious and coordinated fiscal policy response is required to support firms
and workers at risk due to the economic fallout from this shock. This should
include measures such as credit guarantees that limit the threat that a
temporary shortfall in revenue would constrain the subsequent recovery of firms
that were in good shape before this shock occurred. It should also include
support for workers that face temporary declines in wages. More broadly, the
overall macroeconomic orientation of fiscal policy should ensure that the
decline in aggregate private-sector expenditure is not amplified in a
pro-cyclical manner. Accordingly, the Governing Council strongly supports the
commitment of euro area governments and the European Institutions to joint and
coordinated policy action.
     Monetary policy also has a vital role to play. The initial supply side
shock from the coronavirus outbreak has clearly morphed into a demand shock that
deeply affects activity across all sectors of the economy. Moreover, the
economic ramifications of the coronavirus have already been amplified by a
tightening in financial conditions, especially through the decline in stock
prices, rising yields in some asset classes, together with the appreciation of
the euro (Chart 2). This risks triggering a material deterioration in financing
conditions in the euro area.
     Our monetary policy response to this severe (yet ultimately temporary)
shock has three key elements: first, safeguarding liquidity conditions in the
banking system through a series of favourably-priced LTROs; second, protecting
the continued flow of credit to the real economy through a fundamental
recalibration of the TLTROs; and third, via an increase in the asset purchase
programme, preventing that financing conditions for the economy tighten in a
pro-cyclical way.
     It is essential to ensure that liquidity is provided on generous terms to
the financial system, in order to avoid the well-understood spiral effects if an
adverse economic shock is amplified by liquidity shortages: in addition to our
existing regular liquidity operations, the new long-term refinancing operations
(LTROs) provide new lines of funding at a low rate (the deposit facility rate) )
of -50 basis points. Such liquidity measures are especially important under
conditions of heightened uncertainty and when the coronavirus shock also poses
operational risk challenges for many participants in the financial system.
     Especially given the revenue shortfall that is facing small and
medium-sized enterprises (SMEs) and the income shortfall that is facing
households, supporting credit supply can avoid the credit-crunch dynamic by
which banks pull back from lending at the same time as the demand for credit is
increasing. Under the new terms for TLTRO III, we have increased the volume of
funds that banks can borrow from us in order to provide credit to firms and
households by more than EUR 1 trillion. This raises the total possible borrowing
volume under this programme to almost EUR 3 trillion. Banks can borrow at the
most favourable rates we have ever offered, provided that they continue to do
their job of extending credit to the private sector. An important innovation is
that, by setting the minimum borrowing rate at 25 basis points below the average
interest rate on the deposit facility, we are effectively lowering the funding
costs in the economy without a generalised reduction in the main traditional
policy rates.
     Overall, the new conditions on the TLTRO help to significantly ease the
funding conditions that determine the supply of credit provided by banks to
firms and households. In particular, this will support bank lending to those
affected most by the spread of the coronavirus, and especially SMEs. In order to
ensure that banks will be able to make full use of our funding support, we will
also investigate further collateral easing measures. Also, as demonstrated by
this revision, it should be clear that adjustments to the parameters of the
TLTRO programme provides an agile instrument in our monetary policy toolbox, if
the circumstances so warrant.
     In this context, the measures taken by the ECB's Supervisory Board also
provide welcome temporary capital and operational relief to euro area banks.
These decisions show that the improvements in the regulatory framework achieved
over the past years, allow relaxing requirements on banks in a counter-cyclical
way, thereby, complementing well our monetary policy decisions.
     It is essential to ensure a sufficiently-accommodative monetary stance,
especially in an environment of high uncertainty and elevated financial
volatility. The addition of an envelope of an extra EUR 120 billion to our asset
purchase programme (APP) over the rest of 2020 helps to ensure that the euro
area risk-free yield curve - as captured by the overnight index swap (OIS) curve
- supports favourable financial conditions for the real economy. The role of the
APP - both the private-sector purchase programmes and the public sector
securities programme - is especially helpful during a "flight to safety" episode
when investors switch across assets on the basis of the correlation patterns by
which some assets are classified as "safe havens" that gain value during
risk-off episodes. Under such conditions, there are deviations from the typical
co-movement patterns between the GDP-weighted average sovereign bond yield curve
and the respective OIS rates, which call for flexibility in the implementation
of our asset purchase programme.
     The addition of this extra envelope in the asset purchase programme
demonstrates that it is a priority for the Eurosystem to show a more robust
presence in the bond market during phases of heightened volatility. Moreover, we
are committed to use the full flexibility embedded in the APP to respond to
current market conditions. This means that there can be temporary fluctuations
in the distribution of purchase flows both across asset classes and across
countries in response to "flight to safety" shocks and liquidity shocks. Such
deviations from the steady-state cross-country allocation are within the remit
of the programme, so long as the capital key continues to anchor the total stock
of our holdings in the long run.
     We will not tolerate any risks to the smooth transmission of our monetary
policy in all jurisdictions of the euro area. We clearly stand ready to do more
and adjust all of our instruments, if needed to ensure that the elevated spreads
that we see in response to the acceleration of the spreading of the coronavirus
do not undermine transmission.
     Let me touch on a final aspect. You may wonder why, unlike many other
central banks in recent weeks, the ECB did not lower its key policy rates.
Decisions about the short-term policy rate should be understood in the context
of the nature and expected duration of the shocks facing the economy, as well as
the transmission lag of the different monetary policy instruments. For instance,
a move in the short-term rate is typically most powerful if it is expected to be
persistent, given the importance of the expectations channel in determining the
influence of the short-term policy rate on the overall yield curve. This
persistence channel is less relevant in the context of the spreading of the
coronavirus. While this major shock is hitting us at high speed, our baseline
scenario is that it will be ultimately temporary in duration. Accordingly, we
concluded that an easing of the monetary stance through the additional asset
purchases and the considerable support for credit supply through the revised
TLTRO programme is the more appropriate response. However, it should also be
clear that, although the deposit facility rate (the main short-term policy rate)
was maintained in yesterday's decision at its current value of minus 50 basis
points, the Governing Council retains the option of future cuts in the policy
rate, if warranted by a tightening in financial conditions or a threat to our
medium-term inflation aim.
--MNI London Bureau; tel: +44 203-586-2225; email:
[TOPICS: M$X$$$,M$$EC$]
MNI London Bureau | +44 203-865-3812 |

To read the full story



MNI is the leading provider

of intelligence and analysis on the Global Fixed Income, Foreign Exchange and Energy markets. We use an innovative combination of real-time analysis, deep fundamental research and journalism to provide unique and actionable insights for traders and investors. Our "All signal, no noise" approach drives an intelligence service that is succinct and timely, which is highly regarded by our time constrained client base.

Our Head Office is in London with offices in Chicago, Washington and Beijing, as well as an on the ground presence in other major financial centres across the world.