Reflections on ECB policy

As we know, the ECB recently cut its key policy rate by 25bp to 0.5% and narrowed the corridor around the refinancing rate for money market operations to +/- 50bp. The deposit rate was thus left unchanged and stayed at zero.

Mr Draghi was careful not to put a lid on any hopes of further monetary policy accommodation and hopes were kept alive with an array of statements such as ‘continuing to see a downside risk to economic growth’ to stating that ‘the ECB would continue to look at incoming data and stand ready to act’. Indeed, on the deposit rate, Mr Draghi stated that the ECB was technically prepared for a negative rate, but he also reiterated that this could be accompanied by several unintended consequences.

On this front we can note that while the ECB might be technically prepared, negative rates also entail preparing the over 6000 banks that are in Euroland. We thus continue to believe that the ECB will not embrace this option easily, and the economy would need to deteriorate much more significantly before this option would be considered. In any case, such a step would likely come with advance notice since as indicated Euroland’s banks would need to be prepared.

In addition to the rate cut, Mr Draghi was keen to highlight a longer fixed-rate, unlimited funding timeframe. The ECB used to provide unlimited liquidity in six-month steps, but has now extended this to one year. Fixed rate full allotment, which was due to expire in early July, will now be in place for as long as necessary and at least until early July 2014.

When it comes to three-month money, with the last three-month LTRO being conducted at the end of the end of the second quarter next year, in effect this means that unlimited, fixed-rate funding will be available until the end of the third quarter next year, and needless to say, by stating that unlimited funding will be provided for ‘as long as necessary’, the current timeframe can easily be extended further. What this suggests is that the ECB is trying to ensure that it is doing its bit on the supply side by ensuring, as Mr Draghi stated, that the transmission mechanism to the money market is kept alive and that lack of funding provides no excuse for limiting lending.

Despite the good news on rates and funding, it seems that we are still some way from concrete proposals on easier financing conditions for SMEs. This was disappointing but did not really come as a surprise and some of the disappointment is that SME access to finance has been a recognised issue since Mr Draghi took control at the ECB eighteen months ago. It’s apparent that the ECB is stuck in consultations and meanwhile SMEs, especially those in the periphery, are facing tough financing conditions, as evidenced in the ECB’s own survey on the access to finance of SMEs. Officially, the ECB is starting consultations with other European institutions on initiatives to promote a functioning market for asset-backed securities (ABS) collateralized by loans to non-financial corporations.

As to what all this means, in essence, a quarter point cut does not alter the fragile state and outlook for the Euroland economies. Policy measures to improve SME financing at the margin are desperately needed, and Mr Draghi did signal that there would be progress on that front, even if not immediately.

There is a risk that there’s a lot more talk than action and the ECB will have noticed that the OMT promise has delivered the benefits that would have been expected to accompany implementation, without the ECB actually having to buy a single bond. It may be that the ECB hopes to create some demand for credit from SMEs and supply from banks by giving them the hope that a functioning market for ABS collateralized by SME credit claims is in the making. But what’s clear is that promoting a functioning ABS market is still some way off. Not only did Mr Draghi remind on the complexity of packaging and guaranteeing SME credit claims, but he also stated that it all was at the preliminary stage. And in any case, making it official that the EIB and European Commission will be involved is hardly a recipe for swift action! As we have learned through the financial and sovereign debt crises, the more institutions are involved in Europe, the slower the progress.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla