EU breakup

ECB Policy Turns Even More Extreme

March 10th, 2016 by

Just when you thought the world of central banking had lost its collective mind, the European Central Bank (ECB) truly went off the deep end.

It’s like one of those clown cars you see at the circus. Even when it seems that there couldn’t possibly be another person in floppy red shoes crammed into that miniature vehicles, yet another emerges. Like the clown car trick, the ECB is using every quirky smoke-and-mirrors tool at its disposal to try and rescue Europe’s struggling economy and financial system.

Deeper Down the Rabbit Hole

EU breakupAt its policy meeting in Frankfurt, Germany this morning, the ECB took the extreme steps of cutting its already-negative interest rates even lower and increasing its bond purchases to €80 billion per month. In addition to sovereign debt, corporate bonds will now be added to the mix. The rate cut brings the central bank’s overnight lending rate to -0.4%, a decrease of 10 basis points.

In response, the euro instantly sank below $1.085, confirming what most market participants had been expecting. Yet, the common currency bounced back almost immediately above $1.10 due to some contradictory signals from the ECB Governing Council. Even though the decision by the ECB to add more stimulus by was not a surprise, the level of expansion was extreme enough to exceed even the most dovish predictions.

ECB President Mario Draghi laid out revised expectations for future economic conditions. This year’s projected GDP growth was slashed from 1.7% to 1.4%, while the forecast for inflation plunged from 1% (a rather low figure to begin with) to a measly 0.1%.

“This is presumably an example of whatever it takes,” said Stewart Robertson, an economist at Aviva Investors in London, in reference to Draghi’s promise last year to do exactly that to reflate the European economy.

Since global monetary policy is really an interconnected web of decisions that impact one another, the ECB quantitative easing move is sure to have an impact on its contemporaries. The chart below shows the further rate cuts some experts already believed were coming down the pipeline before today’s move.

rate-cuts

Pushing the Extremes

All of these outlandish moves are intended to boost growth and inflation, which the ECB is targeting at 2%. Measured by consumer prices, February saw inflation actually fall another 0.2%. The central bank is encouraging individual European nations to match these desperate monetary policies with fiscal measures of their own. Their level of cooperation remains to be seen.

broken piggy banksSome are speculating that the ECB may soon mirror the Bank of Japan’s move to “pay-to-lend,” where investors are actually paying to lend money while the government is paying to borrow. This upside-down situation, the result of negative interest rates, is proving the situation is even more extreme than the wildest expectations.

Then again, this all fits into what Draghi reiterated just this past January: “There are no limits to how far we are willing to deploy our instruments within our mandate to achieve our objective.” In other words, policymakers will go to any length to bend the laws of monetary physics, so to speak, to try and keep the system afloat.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.