Last round: a new historic package of measures

The European Central Bank (ECB) announced a broader package of measures during its Monetary Policy Committee of March. Furthermore, this decision was voted in by an “overwhelming majority”.

1. Conventional measures:

   The ECB has cut policy rates across the board. While the deposit rate was lowered to -0.4% from -0.3%, the rates on the main refinancing operations and the marginal lending facility were lowered by 5 basis points to zero and 0.25% respectively.

   On the rate side, Draghi did not rule out further cuts to the deposit rate: “Does the cut in the depo rate mean that we can be as low or as negative as we want with rates? The answer is No.” Indeed, the statements made during the press conference support the view that more negative rates may prove ineffective in stimulating spending and could actually weigh on the banking system.

2. Non-Conventional measures:

   The ECB generated a dovish surprise yesterday by delivering a bigger and broader range of easing initiatives than anticipated. Most surprising was the inclusion of non-bank corporate bonds in the composition of the QE programme. This is due to start towards the end of Q2 2016, but corporates have to be “established in the Euro area” and the bonds have to be eligible for repo operations. This will strengthen the pass-through of measures but the design is still a work in progress: the ECB has set up committees to look into this.

3. The table below contains an overview of the measures: 

Economic outlook:

• Macroeconomic developments have been on the downside over the last two months in the euro area and may have played a role in the GC's decision to vote against more aggressive monetary accommodation in March. President Draghi pointed to the clear success of the extraordinary monetary policy (negative rate and QE) measures, and the need to go further:
  • improving bank lending conditions;
  • narrowing the spreads between large firms and SMEs;
  • compressing the spreads between lending rates in vulnerable countries vs. core countries.
• The Eurozone GDP projection was revised down to 1.4% in 2016 (from 1.7%) and to 1.7% (from 1.9%) due to the lower-than-expected outturn for GDP in the fourth quarter and weaker global growth prospects. The 2018 GDP projection is 1.8%.
• Inflation projections were revised significantly down to just 0.1% in 2016 (from 1.0%) and to 1.3% (from 1.6%), largely reflecting the impact of the lower oil prices and lower commodity prices in general. The new projection for 2018 is 1.6%, below the ECB’s target of just under 2%.
• The ECB again underlined its commitment to use all available instruments to ensure that the Euro-area recovery consolidates and that inflation returns to close to, but below, the 2% target.

Impact on our money market fund range

Liquidity & Rate

The increase (20 billion) in the monthly purchase target announced yesterday until March 2017 will increase the excess liquidity path. We expect a liquidity excess of around 1 900 bn € by March 2017.

However, on the rate side, a 10 bp cut in the deposit rate will plunge the EONIA deeper into negative territory. Theoretically, the EONIA will lower to a level between -0.34% and -0.35%. However, with the decrease in the volume traded, we could expect the EONIA to be a bit higher, and stay between -0.30% and -0.33%.

Despite these measures, all short-term rates, surprisingly, rose (Euribor futures, and 2-year govies) after the ECB meeting. Operators seem to remain focused on the deposit rate cut ending: “The ECB sees no need to reduce rates further.”

ECB measures and credit impact

The ECB widened the corridor between the refinancing rate and the deposit rate and could further penalize those main banks with heavy cash-on-deposit accounts. In this new galaxy of rates, the banks will be urged to opt for less excess liquidity and to increase the lending supply to the real economy. In other words, these measures highlighted the ECB’s willingness to support a gradual macroeconomic recovery in Europe.

Conclusion

One thing is certain: monetary policy is, and will remain, accommodative for as long as necessary via the additional implementation of unconventional measures.

Our funds are geared in this direction to outperform our benchmark in such market conditions:

• Overweight Credit and search for higher-yielding issuers (with a minimum short-term rating of A2/P2);
• Optimal duration allocation, with a neutral stance, to avoid rate volatility;
• Take advantage of rate overreaction: thanks to our swap strategy (by temporarily reducing our duration), we can capture market inefficiency.