The ECB’s announcement this week that it will reduce interest rates again, for the first time since 2016, as well as restart its programme of QE stimulus has sparked a mixed response from financial markets and political figures.
USA president Donald Trump was quick to fire off a rebuke, accusing the European Central Bank of intentionally weakening the euro – an accusation Mario Draghi, the bank’s president was quick to refute. Trump’s obligatory tweet read:
“European Central Bank acting quickly. They are trying, and succeeding, in depreciating the euro against the VERY strong dollar, hurting US exports . . . And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!”
The ECB has opted to deepen its move into negative interest rate territory, cutting its rate on deposits from minus 0.4% to a new record low of minus 0.5%. Commercial banks were quick to criticise the decision, with some going as far as to suggest that sustaining the current period of negative interest rates could lead to a collapse of the Eurozone’s already fragile banking system. Draghi’s response was that higher interest rates were clearly in the interests of commercial banks and that their objections could be seen in that light rather than the ECB’s move representing any genuine threat to the financial system.
The ECB has however taken steps to counter concerns. A tiering system will be introduced to protect a portion of banks’ excess deposits from negative rates. The system follows an approach already trialled by other regions with negative interest rates such as Japan, Denmark and Switzerland. The tiering will assist richer banks from northern Europe with excess deposits. Cheap loans as part of the ECB’s ‘targeted longer-term refinancing operation (TLTRO) will help southern European banks with higher funding costs. Even if some bankers were unhappy with the interest rate decision, the market reacted positively with banking stocks initially up – Italy’s UniCredit and Germany’s Deutsche Bank by more than 1% each.
That perhaps counter-intuitive surge continued over Friday. In fact, at 2.4%, it was the biggest weekly gain for Eurozone banks since March 2017 – helped along by an additional boost for Deutsche Bank, up 3%, as it paid $15 million to settle claims it conspired to rig prices of bonds issued by Fannie Mae and Freddie Mac, becoming the first of 16 financial services companies to settle litigation by investors. Analysts believe the central bank’s easing of the terms of its long-term loans to banks and introduction of tiered deposit rate has compensated for the pain of negative rates in the eyes of investors.
The ECB announcement of further QE, worth €2.6 trillion, has triggered a surge in the price of Eurozone bonds, pushing yields down. Germany’s 30-year bond has been driven back down into negative yield territory, which effectively means the country’s government can borrow for free. The central bank is practically telling Eurozone governments, particularly Germany which has recently slid into recession territory, to increase their spending.
Donald Trump’s accusation that the ECB is intentionally driving down the value of the euro to make Eurozone exports more competitive was given short shrift by Draghi, who countered:
“We have a mandate. We pursue price stability. And we don’t target exchange rates. Period.”
The U.S.’s Federal Reserve was also expected to bring down interest rates next week. That move now looks almost certain. Anything else would be expected to ignite all-out war with the Trump administration, with whom relations are already strained in a unique way.
However, not all observers were convinced that the ECB’s moves will prove to be as significant as others seem to expect. Quoted in the Financial Times, Capital Economics’ chief Europe economist Andrew Kenningham commented:
“On first glance this looks like a pretty dovish package. It remains doubtful, however, that this will do much to reboot the eurozone economy let alone achieve the near-2 per cent inflation target.”
But for now, European financial markets seem to be taking a more positive view of the policy announcements. Commodity-linked miners, which rely on strong trade conditions, jumped 2.7%, leading gains among major European sectors and car manfacturers were boosted by fresh signs the USA and China could be making progress in talks aimed at ending their ongoing trade war.
The STOXX 600 and Eurozone-only equivalent index were both up by over 1% for the week and defensive stocks such as food and beverages were the biggest losers, indicating investors were choosing to take their money out of safe havens – a sign of market approval for the ECB’s moves.
Mario Draghi of course ends his period as President of the ECB later this year when he will leave the position. This meant he was particularly open about the bank’s decision to reintroduce QE when questioned on the matter. Asked if the decision had been taken as a message to Eurozone governments (to start spending more) he responded directly with a ‘yes’.
But there is far from universal backing of the strategy within the ECB and wider Eurozone political circles. It has been reported that up to 9 members of the ECB’s council, which makes interest rate decisions, argued against the package during Thursday’s meeting. One German tabloid labelled the move as an attack on ordinary savers.
While it is common to have a level of disagreement with the ECB’s governing council, open dissent is extremely rare. Northern European members of the council have been most critical with Klaas Knot of the Dutch central bank, Robert Holzmann, governor of Austria’s central bank, and Bundesbank president Jens Weidmann all making statements indicating clearly they did not agree with the decision.
Mr Weidmann told German newspaper Bild Zeitung that he felt the policy announced by Mr Draghi “overstepped the mark” in the context of how he viewed the current state of the Eurozone economy:
“The economic situation is not all that bad, wages are growing strongly, and the spectre of deflation – that is, of persistently contracting prices and wages – is nowhere to be seen.”
German commentators also raised the opinion that the previous rounds of ECB QE and lowering of interest rates have proven ineffective and cheap money stimulated speculative investment rather than the deeper structural reforms required. Stubbornly low inflation, being dubbed ‘Japanification’ is seen by many as the Eurozone’s core economic issue. With negative interest rates and QE not so far doing much to change that, there is a growing feeling that these may not be the tools the job needs.