ECB Cuts Rates and Restarts QE Program

ECB Cuts Rates and Restarts QE Program

17 September 2019

              The European Central Bank decided to further cut rates and to re-start its QE program of purchasing bonds. These are one of the last decisions approved by the ECB President Mario Draghi, whose term is coming to an end soon. They came as quite shock to the market.

The Last Decisions

              The ECB’s council announced one of its last decisions under Mario Draghi’s term. Actually, its penultimate before he steps down next month. And these proved to be his wins as he put forward decisions that both the Netherlands and Germany were against, and some of them quite shocking for the market. Firstly, the council decided to further cut interest rates – from minus 0.4% to minus 0.5%. Banks will be entitled to get exemptions from negative rates as lenders expressed dissatisfaction over influence of the cut on their profitability. Additionally the bank will relaunch its debt buying program. Starting from November it will buy debt worth 20 billion euros each month. The guidance on interest rates will be changed to one foreseeing present rates or lower until inflation is right on its way to reach its goal of below 2%. Also it cancelled a 10-basis point rate premium that referred to its long-term loan program. The banks previously stated its costs will remain unchanged until at least middle of 2020.

A Shocking Twist

              The ECB’s bank decision to re-start stimulus program to buy euro bonds came as shock for the market. It is a remarkable twist as nine months ago the ECB gave signs it shall put the QE aside for good. But as the inflation is just at half of its goal and there are concerns about manufacturing sector slowdown that might spread to the whole market, the policy makers apparently decided to act. Upon the announcement, the European government bonds’ prices surged. Especially Italian securities rallied and 10-year yields hit record low. Additionally the exchange rate of euro got weaker against major other currencies whereas Stoxx Europe 600 Index hit its highest point since July.

Will It Be Enough?

              The market might be optimistic now but there are doubts this policy will prove effective in the long-term. The economic slowdown is on the roll and already the long-term bond yields went drastically down. The new round of bond purchase might not prove enough to change the downward trend. Also there are studies claiming that negative rates actually don’t decrease lending. Lenders are forced to absorb the costs of negative rates as they are not the ones to be easily pass to customers.

Will the FED Follow Suit?

              What about the US Federal Reserve plan? As the ECB’s announcement was made public, the US President Donald Trump tweeted that the euro-zone bank is “acting quickly”, while the FED “sits, and sits, and sits”. Previously Trump stated that the FED should follow the ECB’s loose policy and further cut rates. Trump’s wish might soon be fulfilled as the FED is likely to cut rates for the second time this year soon. Central banks around the world are turning to more gentle policy in a bid to fight economic slowdown.