CORONAVIRUS and CENTRAL BANKS: A REALLY HARD EXAM
Coronavirus and Central banks are too closely related nowadays. Following the widespread risk of contagion from Covid 19 and consequent possible recession, on 3 March 2020 the Federal Open Market Committee FED intervened in a peremptory way by cutting the official rate on the FED Funds by 50 basis points bringing it in the range 1-1.25% in order to counter the sell-off on the stock market and the increase in credit spreads on the bond asset.
The Bank of England Monetary Policy Committee also replicated the Fed’s orientation on 11 March by voting unanimously to cut the 50 basis points of the official rate to 0.25%, together with a new term funding scheme financed with bank liquidity. and additional incentives for small and medium-sized enterprises; a scheme this, very similar to our European TLTRO III.
Moreover, it is not an irrelevant consideration that the previous decline in the yield curve of the German government Bund has already led us to foresee cuts in official rates on European deposits of as much as 20 basis points during 2020. In addition, while admitting that in doing so, the ECB would exhaust the monetary boosting tools available to it judging from the observation of futures and forward contracts on the overnight rate, many market analysts expected 10 basis points cut.
Until February, it was now common belief among market operators that already in the closing stages of his mandate Mario Draghi had almost totally fired the cartridges left in the ECB rifle at the end of 2019, so the most likely command in Lagarde’s hands were:
- an appeal to a more massive Quantitative Easing;
- and funding for small and medium-sized enterprises,
measures considered more effective than the rate cut, for the real economy.
Some analysts hypothesized the return to a ‘ radical ‘ Quantitative Easing that is similar to that seen in the phase prior to the current Asset Purchase Program, therefore of a substantial amount, up to 80 billion euros per month. Indeed, it is not a trivial thesis that Quantitative Easing is the most incisive method in terms of positive effects :
- on industrial production,
- on retail demand e
- inflation
with effects in terms of GDP, similar to an expansive fiscal policy. That’s why coronavirus and central banks are closely related.
THE COST OF QUANTITATIVE EASING
On the other hand, evaluating the Quantitative Easing from the point of view of the effect on the average cost of debt capital of companies that had issued ‘ eligible ‘ bonds, that is, purchasable by the ECB because they have an investment-grade rating, these would undoubtedly have benefited from a reduction of this cost. Finally, it should not be forgotten that there is a limit of 33% maximum that can be purchased by the ECB on government issues, a limit that has already been reached in the cases of the German and Dutch government.
As already highlighted, the ECB has almost run out of ammunition and no longer has many effective tools.
The technical evaluation of quantitative easing and TLTRO
In this sense, Quantitative Easing and TLTRO could be joint interventions. It was not implausible, therefore, that the intervention was twofold, i.e. characterized by both cuts and quantitative easing, or threefold with rate cuts, quantitative easing, and expansion of the negative rate exemption share of excess bank reserves ( tiering ) for a larger multiple of the reserve. mandatory compared to the current one ( 6 times ). However, this consideration did not exclude a cut by 20 basis points by the summer in order to counteract the revaluation of the euro. In this regard, we would like to remind you that the money markets, in particular the forward contracts on the EONIA Overnight Index Swap s, recorded a price of -60 / -65 basis points in the days preceding the monetary announcement, effectively pricing a cut of about 10 basis points in the official deposit rate.
Turning to some brief considerations on the Bank of England maneuver of March 11, the writer claims that the British monetary announcement gave true clues about the contents of Lagarde ‘s declarations of the following day. In addition to the rate cut for the MPC’s 50 basis points, the Financial Policy Committee of the British central bank introduced the countercyclical capital buffer cut for banks from 1% to 0% which would facilitate an additional release of credit to the economy for 190 billion pounds, thus avoiding any type of quantity easing. The Bank of England offered liquidity to companies in a similar but not coincident way to a classic European TLTRO.
In the British case, the subsidized loan to each recipient bank is initially equal to 5% of its outstanding loans to the real economy each additional net loan to non-SME companies will result in subsidized liquidity to the bank of the same amount, each additional net loan to PMI will give banks access to subsidized rate liquidity equal to 5 times this amount.
THE ECB DECISION OF 12 MARCH
To solve coronavirus issue, ECB tLet’s briefly see the measures taken by the ECB on March 12th. Rates remain unchanged :
- at 0% the main refinancing operations rate,
- the margin lending facility rate at 0.25%,
- finally, the deposit rate remains at -0.50%.
It introduces temporary addition of LTRO ( Long Term Refinancing Operations ), that will be the bridge to obtain liquidity from banks by TLTRO III by June 2020, new money injections for banks which will apply more favorable conditions for the period June 2020 – June 2021 and the rate applied to them in this period will be 25 basis points lower than that applied to the main refinancing operations ( MRO ), therefore -0.25%. The package is completed by the expansion of the TLTRO III stock to 50% of eligible credit outstanding as of February 28, 2020. Finally, as part of the Asset Purchase Program, Lagarde announced purchases of securities for an additional 120 billion in total by the end of the year. Central banks must increase the total program in order to fight against the effects of coronavirus.
Package that the writer evaluates valid and presumably effective because it would not penalize the already weak banks’ interest margins.
The New Quantitative Easing against Coronavirus
The new Quantitative Easing, if aimed at corporate debt, should revive the fortunes of large companies that finance themselves on the bond market and the revised TLTRO III should restore oxygen especially to countries whose production fabric is made up of small and medium-sized enterprises.
The yield of the generic ten-year BTP showed an upward spike up to 1.50% immediately after the ECB announcement, then corrected and moved to the 1.36% area and finally, unfortunately, surged towards the 1.89% area during the ECB press conference due to some unwelcome statements to the market like ” our role is not to reduce the spreads between government bonds that seem to worry investors “.
Lagarde said that at the end of the APP there will be convergence for each European country towards the capital key, that is, that the purchases of securities are proportional to the shares in the ECB capital held by the respective central banks.
LAGARDE’S PRIORITIES AND LAST WORDS
The Lagarde priority remains the flow of credit to the economy, liquidity, production, and prices, but not the fluctuations of the euro-dollar exchange rate. Yes, in this difficult moment Lagarde showed the firmness and fighting spirit of his predecessor Mario Draghi.
The response to markets and the real economy, but now it’s up to European governments to implement coordinated and effective fiscal policies.
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