Since 2014, the European Central Bank (ECB) has been organizing a conference every June in the Portuguese city of Sintra. Like every year, Mario Draghi, the bank's chairman, opened the meeting with a speech this year. This time again it contained some interesting things.
First of all, Draghi said that the ECB has no taboos when it comes to using unconventional means. "There is nothing institutionally or legally in the eurozone that prevents us from making policy even looser," he said. The ruling of the European Court of Justice that OMT (comparable to purchasing government and corporate bonds) is not in conflict with the Maastricht Treaty, gives the ECB plenty of room.
Risks have not disappeared
Furthermore, Draghi said that the risks to economic growth (geopolitical developments and protectionism) have not yet disappeared. "If we want to prevent inflation from rising to the target rate, additional support will be needed." At first glance, that's old news. The ECB has been promising to intervene for some time if the situation worsens. However, there was one small difference: it is no longer the case that a worsening of the prospects is necessary for the implementation of broader policy, because Draghi states that the postponement of improvement is now also a reason. He thus lowers the bar for interest rate cuts and the start of quantitative easing.
It immediately became clear that the above was not a slip of the tongue by the chairman. For example, he said that the ECB board will discuss in the coming weeks how to adjust the instruments given the risks to price stability. The board can adjust various instruments (such as purchasing government and corporate bonds) to reuse them.
Further reductions
Then it came: "Further cuts in interest rates and measures to neutralize negative side effects remain a policy instrument." He talked about interest rates. In short: the ECB can also reduce the official interest rate below 0%, not just the negative deposit rate. If a reduction in the latter affects the profitability of the banks, which the ECB euphemistically describes as a negative side effect, the bank will come up with even more measures to combat these consequences. to avert. In other words: the ECB is already very activist, but will become even more so in the future.
In addition, Draghi said that the limits imposed when deploying these instruments are specifically linked to the circumstances at the time. “If the crisis has shown anything, it is that we will do everything we can to achieve the target,” he concludes. It is no coincidence that he said earlier in his speech that there are no legal and institutional restrictions. His words sound hollow, but are in fact a verbal bomb. Consider, for example, the limitations on how many government bonds the ECB may purchase a maximum per issue or publisher. What the chairman says is that the bank can change those limits.
Relax the rules of the game
It is not surprising that the ECB wants to relax the rules of the game. To make a new round of purchasing government and corporate bonds effective, it will have to be larger and more extensive than what the ECB has done up to and including December 31, 2018. The bank could decide to buy more supranational bonds issued by the European Emergency Fund or the European Investment Bank. Or even to change the distribution key (the amount per euro country).
In July 2012, Draghi spoke in London. The euro crisis was at its peak at the time: the question was whether the euro would survive the crisis. Draghi uttered the now most famous words in the history of the ECB: 'whatever it takes'. That moment is now seen as the moment when the euro was saved. Interest rates in the weak euro countries fell and confidence in the currency rebounded. All in all, I describe his speech in Sintra as a repetition of 'whatever it takes', but this time with the addition 'and for as long as it takes'.
Between now and the summer of 2020, I expect the ECB to further cut interest rates and restart buying corporate and government bonds. Regarding the first, I take into account an official interest rate of -0,10%. With regard to the latter, I expect that purchases will certainly be made for approximately €50 to €60 per month for a longer period of time. In other words, EURIBOR rates could fall even lower and long-term interest rates will remain under downward pressure for now.