By Paul J. Davies and Anna Isaac
European Central Bank President Mario Draghi has said he is ready to throw everything at the problem of persistently low inflation. On Thursday, he pretty much did.
The ECB cut interest rates and announced a new bond-buying program and several measures mainly designed to help banks. In response, the euro tumbled by as much as 0.5% and government-debt yields fell, with German 10-year bonds down by 0.08 percentage points and Italian 10-year rates dropping more than two-tenths of a percentage point.
But markets reversed direction equally abruptly once investors absorbed the details and realized Mr. Draghi's press conference wasn't going to deliver any extra punch. Here's five things you don't want to miss in the ECB's policies:
Infinity and Beyond!
The new asset-purchase program, at EUR20 billion ($22.1 billion) a month, was less than the roughly EUR30 billion a month that investors had anticipated. But the quantitative easing program is open ended, meaning it will go on as long as it is deemed necessary. That is a surprise. The ECB wasn't seen as having much bond-buying capacity because of self-imposed limits on how big a share of each country's bonds it is allowed to own. And it didn't change those limits.
However, it did make other key changes. For starters, the ECB can now target a wider pool of assets, including private-sector bonds -- such as corporate debt and mortgage-backed bonds -- trading with yields that are lower than the ECB's interest rates. That means it can keep buying bonds for a long period -- some analysts estimate two or three years -- before its has to face a politically tricky discussion about lifting its government-bond ownership limits.
Tiers for Fears
Negative rates are painful for banks, especially with more quantitative easing on the way. QE programs leave banks with an ever-growing pool of reserves kept at the central bank. When rates are negative, those reserves are a burden for the lenders. At the new interest rate of minus 0.5%, the cost to eurozone banks would be more than EUR9 billion a year, according to ABN Amro analysts. This rising cost gives banks an incentive to start charging more for loans to make up the difference, undermining the central bank's effort to cut borrowing costs in the economy.
To combat this, the ECB now has a two-tiered system for charging interest on those deposits. Required reserves, and excess reserves worth six times those required reserves, won't be charged. Any deposits in excess of that level will draw a charge from the negative interest rate. The upshot is that the cost of holding excess reserves will be only about EUR5.6 billion, according to ABN Amro.
Another boost for banks came from a new lending program that is more generous than earlier iterations. The third so-called Targeted Long-Term Refinancing Operation, or TLTRO III, will be longer term and at a lower interest rate. These loans are meant to be used by banks to fund loans for companies and households to aid investment in the economy. The funding will be for three years, instead of just two, and the banks will be paid more for using it if they grow their productive lending by more than a pre-agreed amount.
The banks can get paid for the funding because it too can be priced at the full level of the ECB's negative interest rate. When this policy was sketched out previously, the ECB said the funding would be priced at one-tenth of a percentage point above ECB interest rates.
The biggest surprise of the day, according to some economists, was the change to the ECB's "forward guidance" and what it says about when ultraloose policy might end. This is a portion of the central bankers' speech that has come to be seen as a policy instrument in itself around the world since 2008. It is designed to influence how consumers and investors think about what is going to happen to inflation.
Mr. Draghi said he wanted inflation to "robustly converge" to the target level of below but close to 2%, to ensure "ongoing buildup of domestic price pressure." That is meant to jolt inflation off its rock-bottom rate.
One of the problems for the ECB is that the U.S. Federal Reserve is set to cut rates again. Lower U.S. rates could weaken the dollar against the euro, especially if there is a breakthrough in the U.S.-China trade war that helps to reverse the global economic slowdown. That could cause problems for the eurozone if a stronger euro feeds through into lower import prices and dampens inflation.
On the other hand, some analysts think that linkage has diminished and a weaker dollar won't suppress European inflation. But what is certain is that President Trump is convinced ECB rates cuts do weaken the euro, complaining about just that on Twitter again on Thursday. An angered Mr. Trump could bring his trade war to Europe, too. That certainly won't help Mr. Draghi, or the next ECB president, Christine Lagarde.
Write to Paul J. Davies at firstname.lastname@example.org and Anna Isaac at email@example.com