What Mario Draghi Did Today: Goldman Sachs Explains

Since Mario Draghi is merely a frontman for (and former employee of) Goldman Sachs in yet another central bank, and since his policy mandate is implemented only after extensive drafting and pre-clearance with 200 West, the best "most-mortem" of what happened today comes from the firm that was responsible for today's announcement in the first place: Goldman Sachs itself.

So here it is, via Goldman's Dirk Schumacher:

ECB announces wide range of measures

Today, the ECB cut the MRO and the deposit rate by 10bp and the marginal lending facility by 35bp. In addition, it announced several measures aimed at reviving lending to the corporate sector. It is difficult to say with certainty at this stage what the net effect of these different measures will be on lending and the economy. But the ECB has clearly bought itself time before engaging in further measures. The next step will be outright purchases of ABS, for which the “preparatory work has been intensified”. There was no indication that the Governing Council was moving closer to a large-scale asset programme, even though it was not ruled out. Overall, the cut in the policy rates was a bit smaller than we had expected, but the credit easing measures were more meaningful than our prior expectations.

Ongoing gradual recovery

The ECB continues to expect the “gradual” recovery to continue, although first quarter GDP was “somewhat weaker” than expected. Indeed, the updated staff projections show a small upward revision to next year’s growth, to +1.7% compared with +1.5% previously (the 2014 forecast was revised down to +1.0% from +1.2%). As in previous months, the ECB sees the risks to the growth outlook as being to the “downside”.

The updated staff projections also show a downward revision to the inflation forecast for this year, to 0.7% (+1.0% previously) and to 1.1% in 2015 (from +1.3%) and +1.4% in 2016 (from +1.5%). By the end of 2016, the staff now expects inflation to be at +1.5%, compared with +1.7% previously. This raises the question of whether the +1.5% forecast can be considered close enough to the ECB’s target of medium-term price stability, and hence a signal for future action. Mr Draghi did not dwell on this point during the press conference, but it is noteworthy that these projections do not yet incorporate the new measures announced today. Thus, one should not necessarily interpret the new forecasts as a signal that further significant steps are imminent. That said, it is also the case that Mr Draghi did not rule out the possibility that more is coming.

Close to lower bound for rates

When asked during the press conference whether further rate cuts were likely, Mr Draghi appeared to signal that the lower bound had been reached. To be sure he did not rule out the possibility of further small cuts but neither did he suggest that this would be the preferred choice. One interesting detail of today’s decision was that the marginal lending facility was reduced by more than the MRO or depo rate, thereby establishing a symmetric corridor again. We interpret this narrowing of the corridor from the top as an attempt to reduce the volatility in EONIA.

One ordinary (but capped) 2-year LTRO plus a Targeted LTRO

The ECB will conduct 2 TLTROs in September and December this year. Banks will be allowed to borrow 7% of their outstanding loans to the non-financial private sector excluding mortgages (according to the ECB, this amounts to €400bn). In our understanding, banks can post any eligible collateral for these two operations. The interest rate of the TLTROs – the MRO rate at that point in time plus 10bp – will be fixed over the maturity of the operation. There will be four additional TLTROs between March 2015 and June 2016. Borrowing under these operations can be up to three times a bank’s net lending to the Euro area private sector (excluding mortgages) between April 20, 2014 and the allotment date of the TLTRO. All TLTROs will mature in September 2018. Should net lending be lower than a – yet to be determined – benchmark, banks will be required to repay their borrowings by September 2016.

The main difference between these new Targeted LTROs and the previous ones is that banks will have to increase their net lending to the private sector in order to get the full benefit of the 4-year maturity. But for those banks that are not willing or able to do so, the ECB has offered a regular 2-year LTRO at 25bp. It is difficult to say ex ante how much demand there will be. But given that a positive carry exists between such 2-year borrowing and (say) peripheral sovereign debt, we could see significant take-up and a resulting net injection of liquidity.

“Intensifying the preparatory work” to buy ABS

The Governing Council also announced that it has moved closer to buying “simple and transparent ABS” with claims against the Euro area non-financial private sector as the underlying asset. No further details have been announced so far, but we think the ECB is likely to announce a programme in the coming months. The stock of traded ABS that fulfil these criteria, however, is rather small and geographically concentrated.

Nothing specific on QE

Mr Draghi was asked several times during the press conference about the likelihood of a large-scale asset purchase programme. As expected, Mr Draghi did not rule out this possibility, saying that it was an option should the need arise. But he gave no further hint as to whether Fed-style QE involving significant outright purchases of domestic sovereign debt has become more likely. In any case, the ECB will first want to see how the new measures work before it considers a QE programme in earnest. We continue to assess a probability of just 15% to an LSAP programme involving sovereign debt through year-end.