ECB stimulus comes with hidden message on interest rates
European Central Bank chief offers lenders a fresh round of cash to keep them afloat and make them support a recovery by encouraging lending
Bloomberg in Frankfurt
Mario Draghi's latest stimulus tool contains a hidden message: if you think interest rates will rise before 2018, take the money now.
The European Central Bank president has offered lenders a fresh round of cash for as long as four years to keep them afloat and make them support an economic recovery by encouraging lending.
He is also inviting bets on when the ECB will scale back its ultra-loose monetary policy - the more a bank expects borrowing costs will rise over the term, the more attractive the loan looks.
Four weeks after the ECB unveiled an unprecedented plan for boosting the euro area's floundering revival, economists and investors are still grappling with its intricacy.
While Draghi is trying to reassure investors that the ECB will keep policy loose for longer than the US Federal Reserve and Bank of England, the link between the size of stimulus now and the prospect of higher rates later is a reminder that cheap money will not be around forever.
"Draghi's latest move has stepped up the complexity of monetary policy, though simpler options exist," said Andrew Bosomworth, the managing director of Pacific Investment Management. "I'd reserve judgment until we see results from the economy, but if I were trying to make a guess, it would be a 50-50 call whether it's going to work or not."
So far, the ECB's package has prompted a plunge in money markets. Overnight interbank borrowing costs in the currency bloc averaged 0.06 per cent last month compared with 0.25 per cent in May. That is probably enough to stave off further action for now. Economists expect the ECB's governing council will keep interest rates unchanged when it meets on Thursday.
The impact on the broader economy may take longer to materialise. Inflation in the 18-nation bloc held at 0.5 per cent last month, about a quarter of the ECB's goal, according to figures released yesterday by the European Union's statistics office. Lending to companies and households in the euro area fell for a 25th month in May.
The latest addition to the ECB's policy alphabet soup - TLTROs, or targeted longer-term refinancing operations - as a response to fading price pressures is more than a standard supply of central bank cash. While banks can borrow funds for two years with no strings attached, and even use them to roll over existing emergency ECB loans, they must prove the money has been lent on to companies and households if they want to keep the funding until the programme ends in 2018.
At the same time, Draghi pledged to keep official rates low and extended until the end of 2016 a policy of providing as much short-term liquidity as banks request. That creates a quandary - determining which funding source is cheapest.
Banks can borrow in the ECB's weekly and three-monthly operations at the benchmark rate, currently 0.15 per cent. While the TLTROs will be priced at a 0.1 percentage point premium, and so probably cost 0.25 per cent in the first round of offers, the rate will be fixed for the term of the loan. The appeal therefore hinges on banks' expectations for when and by how much the benchmark rate will increase.
"It's a bit of a conundrum," said Nick Matthews, a senior economist at Nomura International in London. "The programme can be interpreted to suggest the ECB could be open to increasing the refinancing rate sometime in 2017, when the actual message and focus should be on the fact that rates will stay low for an extended period."