EMU: ECB Announcement

Thu Jan 22 06:45:00 CST 2015

Consensus Actual Previous
Change 0bp 0bp 0bp
Level 0.05% 0.05% 0.05%

Having already been described by the central bank as being at their lower bound, the ECB duly left benchmark interest rates unchanged today. The refi rate remains at just 0.05 percent and the rates on the deposit and marginal lending facilities stay at minus 0.20 percent and 0.30 percent respectively. There is nothing here to surprise anyone.

However, with financial markets seeking confirmation that the monetary authority has finally pulled the trigger on QE, today's focus was always going to be ECB Chief Draghi's press conference. After weeks of rumours and supposed leaks, speculation had centred on a stimulus package entailing purchases of sovereign bonds to the tune of E50 billion a month, possibly through December 2016.

In practice the ECB probably more than matched market expectations. QE will be introduced from March and run through to the end of September 2016 with the option of an extension should inflation goals remain out of reach. Including the existing ABS and covered bond programme already announced, total buying going forward will be E60 billion a month directed at maturities between two and thirty years. On this basis the total package could be worth around E1.1 trillion. Sovereign bonds under consideration will need to be of investment grade (ruling out Greece for now) and some 80 percent of the risk will be carried by the national central banks. The ECB will also trim the rates on future targeted long-term repo operations (TLTROs) to match the prevailing refi rate.

Financial markets had already priced in much ahead of this announcement but probable relief that the central bank has lived up to expectations has seen European equities initially respond favourably and the euro has taken another leg down. In any event, this is effectively the ECB's last available major policy tool to turn the Eurozone economy around and clearly the risk is that even this stimulus proves to be too small, too late, or both.

Investors can take heart from the fact that the European monetary authority has at last opted to follow the Fed and BoE route and the fact that the measures are effectively open-ended. However, they will no doubt want to see early results. In the meantime, the region's markets face another major threat to stability in the shape of the Greek parliamentary elections on Sunday.

Note that as of this year the central bank has switched to 6-weekly intervals between meetings so the results of the Council's next policy deliberations will be announced on 5th March.

The European Central Bank announces its monetary policy with regard to interest rates and any other major policy initiatives usually during the first of its two meetings held each month.

The European Central Bank determines interest rate policy at their Governing Council meetings. The Council is composed of the six members of the Executive Council and 17 presidents of member central banks (Bank of France, Bundesbank, etc). The Governing Council meets twice monthly (usually the first and third Thursdays of the month). Monetary policy issues are generally discussed only at the first meeting of the month. The European Central Bank has an established inflation ceiling of just less than 2 percent. The ECB's measure of inflation is the harmonized index of consumer prices (HICP). Each member of the Governing Council has one vote and decisions are reached by simple majority. In the event of a tie, the President has the casting vote. No minutes are released so how individual members voted is not known.

As in the United States, European market participants speculate about the possibility of an interest rate change at these meetings. If the outcome is different from expectations, the impact on European markets can be dramatic and far-reaching. The rate set by the ECB serves as a benchmark for all other interest rates in the Eurozone.

The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the stock market, while lower interest rates are bullish.