Yves Nosbusch


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An important step by the ECB



The Governing Council of the European Central Bank (ECB) has acted decisively. As well as cutting its main policy rates, its president has announced a novel long-term refinancing operation targeted directly at the real economy, and an intensification of preparatory work on outright purchases of Asset Backed Securities (ABS). What impact are the measures, announced on 5 June, likely to have? And will they be enough to bring eurozone inflation closer to the ECB's 2% target?


ECBImpaired transmission mechanism

A central bank normally influences economic activity and inflation by setting short-term interest rates. When it lowers rates, investment becomes more attractive (because new projects are cheaper to finance), as does consumption (because savings earn less interest). This process stimulates demand and, ultimately, inflation. At the moment in the euro zone, this mechanism is impaired. The ECB's recent rate cuts have had less of an impact than usual. Lending to individuals has barely risen, while lending to businesses has continued to drop even though short-term interest rates are close to zero.


Accordingly, the ECB has just introduced a package of measures to stimulate credit and domestic demand. In addition to cutting the refinancing rate – the rate at which commercial banks borrow from the central bank – from 0.25% to 0.15%, the Governing Council lowered the rate on the deposit facility to -0.1%, thereby introducing a negative interest rate for the first time. This means that, going forward, banks will have to pay to deposit money with the ECB. The aim of the measure is to encourage banks to increase lending to households and businesses. The impact may well be limited however given that the use of the deposit facility has already fallen off sharply since its rate was set to zero in 2012.


Another innovative measure announced by the ECB is a new type of long-term refinancing operation. In contrast to previous operations, access to funds will be directly linked to the total amount that eurozone banks lend to the real economy. The facility will exclude mortgages to households and should therefore end up mostly supporting businesses. The ECB estimates the potential size of the programme to as much as EUR 400 billion.

Further measures

The ECB has also announced that it will intensify preparatory work on outright purchases of Asset Backed Securities (ABS). Stimulating the ABS market could boost the flow of credit in the euro zone. Converting a larger fraction of bank loans into ABS could indeed get a broader spectrum of investors involved in financing the real economy. However, practical hurdles, particularly in relation to the regulatory treatment of ABS, complicate implementation in the short term.


More broadly, the main challenge facing the ECB is the low inflation rate in the eurozone. The slowdown in inflation observed since 2012 stems from three main factors. First, excess capacity in the zone remains high, despite an encouraging beginning of a recovery. Stimulating credit with the ECB's new measures should help close this output gap over time. Second, oil prices have fallen since 2012, a factor over which the central bank has little control. Third, the euro has appreciated by around 10% against a basket of major currencies between the president of the ECB's announcement during the summer of 2012 that the central bank would do “whatever it takes” to save the euro and the peak reached in early May. The ECB is to some extent a victim of its own success because, by restoring confidence in the euro zone, it has contributed to the return of investors and thereby to the euro's rise.


The next big step for the ECB would be a large-scale bond purchase programme (Quantitative Easing). This type of action is designed to bring down long-term interest rates and risk premia and, indirectly, to lower the exchange rate. A Quantitative Easing programme could be implemented as early as the fall. In any case, the lowering of long-term interest rates, particularly in peripheral countries, together with the recent weakening of the euro suggests that markets are starting to believe it.



Article completed on 5 June 2014 by Yves Nosbusch, Chief Economist of the Bank
Published in the Luxemburger Wort (in French) on 6 June 2014