The ECB had flagged that its September meeting would deliver further monetary easing but it is testimony to the difficulty in managing market expectations that the net result is that policy is now actually tighter . That may change,of course, depending on how events unfold over the coming months but as it stands market rates have risen, as has the currency and short term bond yields, and excess liquidity in the market has actually declined.
Perhaps the most striking change announced by President Draghi was on forward guidance, with the pledge to keep rates at the current level or lower now no longer time dependent but open ended till the inflation target is achieved.The Bank had also spent most of the past five years denying that negative rates were having a materially adverse effect on the banking system but changed tack, with the introduction of a tiering system on deposit rates. Banks are required to maintain a given level of required reserves , currently €132bn, and these are remunerated at zero percent, the main refi rate. Excess liquidity, which stands at almost €1,800bn , is paid at the deposit rate, which at -0.4% cost banks over €7bn a year. The change now means that banks can hold almost €800bn at the zero rate, but still leaving around €1,100bn in excess, now remunerated at -0.5% i.e. a cost of €5.5bn.
Some relief then for banks ,albeit one that was below market expectations, but the ECB also eased the terms on its latest long term loans package for EA banks (TLTRO III), which is now for up to three years at a rate equal to the main refi rate over the period, which is likely to be zero. Indeed, as with the other TLTRO’s, banks that grow their eligible lending by over 2.5% by end-March 2021 will pay the deposit rate, currently -0.5%. From an Irish perspective it should be noted that eligible loans exclude mortgages, which are the dominant lending for domestic banks.
The ECB also announced that QE will recommence in November at €20bn per month, with no set end-date, although it is likely the 33% limit would be hit in many countries after a year or so. The market reaction to all this may change when QE kicks in and when we have seen a number of TLTRO’s but to date policy is tighter than before the meeting; 3-month euribor for December is trading at -0.42%, from -0.54%, while the figure for December 2020 is -0.5% from -0.62%. The outlook for fixed rate mortgages has also changed as 5 year swap rates have also moved higher, to -0.35% from around -0.5% a few weeks ago.
The euro exchage rate, as measured by the effective or trade weighted index, has also appreciated, which one doubts was a policy aim, while short term bond yields have actually risen; the German 2-year was -0.81% and is now -0.70% with the Irish equivalent rising to -0.49% from -0.64%. Banks are the main buyers of this debt and it is less attractive because they can now hold more reserves at a zero rate.
It’s early days, but the first TLTRO 111 actually reduced liquidity. Banks had borrowed €740bn under the previous scheme which with early repayment had fallen to €692bn, with another €32bn due for repayment next week. The take up of today’s first TLTRO III was only €3.4bn , implying a net drain of €29bn. Banks have had little time to prepare and no doubt the take up will improve but it is still a remarkable result.
The market had clearly priced in a lot from the ECB but one doubts that the Governing Council will be pleased by the result, an effective monetary tightening. For prospective Irish mortgage borrowers the result is also likely to mean less downward pressure on rates.