No Big Surprises
Last week, policymakers at the European Central Bank (ECB) and the Bank of England (BOE) responded to concerns over sovereign risks and economic deceleration by opening the taps on monetary policy. Key takeaways include:
1) Interest rate cuts at the ECB
In a resounding unanimous decision, policymakers cut benchmark rates by 25 basis points to a record-low 0.75%. The overnight rate banks are paid for deposits with the ECB was dropped to zero. The ECB stressed downside risks to growth and, for the first time, highlighted that risks to price stability are also weighted to the downside. Reports show that at least seven euro-zone countries are back in recession, and that inflation has slowed for the past three months.
2) No additional unconventional measures
Policymakers at the ECB did not even discuss additional non-standard easing programs. They did this, in part, because other recent decisions—including a move to ease collateral standards for Spanish banks—have not had time to take effect. The ECB also wants the European Stability Mechanism, Europe’s new permanent bailout fund, to do the heavy lifting when it comes to support for challenged government-bond markets.
3) Euro-area economy set for gradual recovery?
The ECB forecasts a moderate reacceleration in economic growth in the second half of 2012. Given current conditions, we think the basis for this is soft.
4) Banking supervision to be separate from monetary decisions
The president of the ECB, Mario Draghi, stressed that should the ECB assume responsibility for banking supervision, it would be completely separate from the ECB’s monetary policy arm. No additional details were provided, suggesting that reforms of the Economic and Monetary Union’s banking supervision is still at an early stage.
5) Ireland: A success story
Mr. Draghi noted that Ireland’s reform program remains on course, and that the country had regained access to capital markets. Ireland received an €85 billion ($113 billion) bailout in November 2010 after real-estate losses brought down the country’s banking sector. Credit-default-swap spreads suggest that Spain is now a greater risk than Ireland.
6) More BOE quantitative easing
In the U.K., the BOE’s decision to hold interest rates steady and increase quantitative easing by an additional £50 billion ($78 billion) was completely in line with market expectations. Total scheduled bond-buying is now at £375 billion ($585 billion). The U.K. fell back into recession in the first quarter of 2012.
Allianz Global Investors' View
All in all, there were no big surprises in the July 5 policy announcements. The absence of non-standard easing discussions at the ECB may have disappointed some investors, but the door is open for rate cuts and unconventional measures at a later date. Our Economics and Strategy Group expects action by year-end. We are also watching for impacts from the ECB’s new zero deposit rate. This could affect repo rates and put further downward pressure on Eonia, Europe’s overnight interbank lending rate. It is notable that the ECB can influence bank liquidity, but not bank investment behavior or private sector demand for credit, which remains weak.