Last week the president of the European Central Bank announced what has been termed as a comprehensive package of monetary easing, including cuts to its deposit, refinancing and marginal lending rates, an expansion in the size and scope of its quantitative easing programme and a second round of targeted long-term refinancing operations for banks. Even just to write it, that was quite a mouthful.
What it meant was a looser monetary policy in the eurozone aimed at injecting more money into the economy with the objective of strengthening the fragile economic growth of the past months and accelerate the inflation rate to close, but below, two per cent. In effect, ECB president Mario Draghi did surprise everyone with this package – and it was a pleasant surprise.
The fact that the rate for refinancing operations is now at zero and the rate of deposits has been brought down to -0.40 per cent should force banks to lend more. Add to this the expansion of the ECB’s asset purchase programme from €60 billion a month to €80 billion a month, and running it to March 2017, and one recognises the pressure that the ECB is putting on commercial banks to lend more.
The current scenario of low interest rates and high liquidity in the banking sector still presents us with opportunities
The ECB also decided to extend the asset purchase programme to investment-grade euro-denominated bonds issued by non-bank corporations established in the eurozone.
It was evident from Draghi’s statement last week that the ECB wishes to increase liquidity in the banking sector with the objective of further incentivising bank lending to the real economy. Looking ahead, taking into account the current outlook for price stability, Draghi stated that he expected the key ECB interest rates to remain at present or lower levels for an extended period of time and well past the horizon of our net asset purchases, that is beyond March 2017.
Up to a certain extent, the decision of the ECB represents bad news. Economic growth is not what it should be. The most recent data available to the ECB point to weaker-than-expected rate of growth at the beginning of this year. The economic recovery will proceed but at a moderate pace, while the low price of oil should contribute further to increasing the purchasing power of consumers as well as the profitability of businesses.
However, the economic recovery in the eurozone continues to be hampered by low growth in the emerging markets and the very slow pace of implementation of structural reforms.
In this scenario, the ECB knew it had to take bold decisions to meet the expectations of most governments and investors. Many analysts spoke of Draghi’s pleasant surprise. Some even dubbed him ‘Supermario’.
The initial reaction of the financial markets was positive, then it turned into negative, albeit for a brief moment, and then it turned to positive again. One needs to remember that last December the financial markets had reacted quite negatively to the decisions of the Governing Council of the ECB because they were judged not to be bold enough.
A very legitimate question is what will be the impact on the real economy. Will such a loose monetary policy leave the effects that the ECB is hoping for? Will banks lend more? Will economic growth be less fragile? Will there be more investment in the eurozone?
To expect the ECB to resolve all the woes of the eurozone economy does not make sense. The ECB has done a great deal to get the banks to increase their commercial lending. It is now up to banks themselves to take the opportunity. Unless there is an increase in lending, investment cannot take off and steady economic growth will remain elusive.
The same can be said about governments and the reforms they are meant to implement. It is hoped that this new round of quantitative easing shall not serve as an excuse for governments to delay further the implementation of these expected reforms. I am not referring to austere fiscal policies. I am referring to the regulatory framework in a number of countries that serves as a disincentive to investment, such as a high level of taxation, or pension reform, or labour legislation. Unless structural reforms are implemented, even if governments abandon fiscal austerity, there cannot be a proper take-off.
Thus, even though the ECB gave us a pleasant surprise with its bold approach, there is still work to be done. It is up to governments and the banking sector to finish the job by recognising that their role is not to be main actors in the real economy but to act in a supporting role, which enables investment and consumption to grow in a sustainable way.
In Malta we are oblivious to all of this. With a growth rate of six per cent in real terms, the last thing we need is quantitative easing. However, I believe that the current scenario of low interest rates and high liquidity in the banking sector still presents us with opportunities that we would do well to exploit.