The increase in liquidity will not be sufficient to fuel the badly needed eurozone’s economic growth. Meanwhile the fiscal policy remains deflationary.
When, two years ago, in a moment of speculative attack on the government bonds of the south euro-countries, Mario Draghi announced the Outright monetary transactions (OMT), he added: "Believe me, it will be enough."
On 5 June, in a calm situation on the front of the public securities, but with forecasts of sluggish economic recovery and inflation, the ECB announced a more permissive monetary policy, approved unanimously, and in answer to a question, Draghi said: "we are not finished here," which we interpret as: I'm not sure that the measures will be effective, and I intend to take more in the future.
The measures laid down are two: one relates to the reduction of 15 basis points in the rate of funding and the introduction of a negative rate to 10 basis points on reserves held by banks at the ECB. The second is a new version of the LTRO (long term refinancing operations), this time with a T in front, which stands for "targeted". From these measures one can not expect too much. Even the introduction of the negative rate cannot significantly influence the behaviour of euro-north banks, those who have excess liquidity, if not in the decision to buy larger quantities of securities.
So is the TLTRO from which Draghi expects better results. These operations allow banks to borrow for four years an amount not exceeding 7% of loans to non-financial private sector in the euro area, with the exception of loans to households for house purchase. The calculation will be referred to the loans in place until 30 April 2014. There will be two TLTRO in September and December 2014.
In addition, during the period between March 2015 and June 2016, banks may require additional amounts. These can reach a maximum amount equal to three times the total amount of additional loans (net) granted to non-financial companies after April 2014. Nevertheless it should be borne in mind that all TLTRO will expire in September 2018. Duration of four years therefore applies only in the case of loans requested in September 2014. The rate to apply by ECB, for the duration of each transaction, is the interest rate on the main refinancing operations (MROs) in effect at the time of disbursement, with the addition of a differential fixed by 10 basis points. Currently, therefore, the cost is 25 basis points.
Although the funding is intended to increase bank lending to businesses, nothing prevents banks to buy government bonds, or perform other financial operations. In this case, however, the repayment of the ECB must take place by September 2016. The period of two years is the minimum, however, as only after 24 months from each TLTRO banks can begin to repay the loan.
The previous LTRO the ECB have been used, especially by the Italian and Spanish banks, to buy government bonds that were sold by financial operators. It is perfectly possible that even new funding can be used, in good part, if not entirely, in the same way. In any case banks would get, for two years, profits without particular risks, playing on the difference between bond yields and the cost of financing. The reason why the banks are afraid to lend to enterprises is that risks are too high. Many companies, despite being financially sound, are reluctant to make investments because they see no prospects for growth in demand; others are short of liquidity, and would like to have credit, but are more risky.
The ECB also announced an "intensification of preparatory work related to outright purchases of ABS... to enhance the functioning of the monetary policy transmission mechanism, given the role of this market in facilitating new credit flows to the economy". When Draghi said the ECB's action was not over, he was referring to ABS. The term is an acronym for "asset-backed security". These instruments are issued as part of a securitization vehicle finance. Behind ABS there are loans, home mortgages, bonds, and the like. These ABS can be brought to the ECB by banks to obtain liquidity at a 'discount' rate.
The ABS has played a leading role in the financial crisis; this is why the ECB is quick to say that tools must be "simple and transparent". Obviously, the role of these tools depends on the rules that govern them, and in particular how it is determined the discount to the face value of the underlying securities. A financial intermediary may be encouraged to give loans to firms, and get free from the risk, but it all depends on the price. The experience in the UK is interesting, but the part of ABS that worked the most is that linked to real estate loans to households, which at first were admitted and subsequently were excluded, as it seems the intention of the ECB.
In conclusion, the measures taken by the ECB are not as revolutionary as it may seem from the news media. We are far from a QE (quantitative easing) as that of the USA. There will certainly be an increase in liquidity, which will benefit, as it is already happening (Italian and Spanish spreads are going down), government securities, particularly in the euro-south countries. But it is very likely that for the next two years the economic growth and inflation will remain low; what we would need is a 180 degree turn in fiscal policy of the euro. At the moment this is an uncertain hope.