Alex Fuste, Economista Jefe Andbank Private Bankers
The ECB meets again. In my view, 100% chance that it is going to say that is prepared to make the decisions, whatever they are, and when necessary … to end the meeting and do nothing despite the fact that inflation is not higher than it was the last time the ECB met. Rather, it is dangerously below the target, at 0.8% yoy.
It is likely the ECB will add additional liquidity to the market (maybe to take some upward pressure off the euro, which is near the top of its trading range), perhaps by announcing the end of the SMP sterilization. This could add up to €175bn of new liquidity and will probably send money market rates and government bonds lower, but we all know that this is just a “minor action” (or a temporary solution) while the bigger guns are still held in reserve.
And then, What after this move? With rates so close to zero, little can be achieved from an additional rate cut. Then, What instruments will be left for adding liquidity? Negative deposits rates? (many believe that this will do more harm to the banks in the periphery)
However, as Nick Andrews pointed out today in a paper, “liquidity in itself is not Europe’s main problem” (banks can still borrow unconditionally under various ECB programs).
Europe’s problem is that liquidity is not channeled through credit in the most needy parts of the Eurozone (well, I’m not discovering anything new).
In that regard, Draghi has properly hinted (several times) that the real solution is to find some kind of targeted lending scheme. Draghi was right when saying that “with an impaired bank lending channel, monetary policy may lose its handle on the real economy, and thus, its handle on inflation”
The Bank of England found that throwing unlimited amounts of liquidity at banks via QE did little to encourage credit (so, Mr Carney stopped expanding money base). Instead, the introduction of a Funding for Lending scheme (forcing banks to prove they have lent money to the private sector to receive cheap liquidity), did much more for the economy.
This Funding for Lending scheme was extended to households and business, and was supported by the government guarantee scheme. Admittedly, it must be recognized that this would entail a de facto increase in government’s liabilities (more debt), household’s liabilities (more debt), and business’ liabilities (more debt). Something that our German’s neighbors do not conceive as a good syrup (and somehow, neither do I).
it must be recognized that this Funding for Lending Scheme, when aggressively extended in the UK, made the shackles to be taken off the UK consumers (specially in the mortgage lending), driving the economy over the last 12months (always according to my British sources). But in a similar manner, it must also be recognized that lending for business in the UK has been less successful.
Then, my question is. Why to implement such a Funding for Lending scheme in the Eurozone if businesses probably will not experience a dramatic change in lending (as seen in the UK)? Why to promote such a scheme if the most probable beneficiary will be the mortgage sector? (actually something to be considered knowing that the housing sector is at all time highs in Germany and that there is a serious oversupply problem in Southern Europe. Yes, one could easily conclude that it would be probably not a good idea to reheat this sector).
Of course, the guys from London argue that although this scheme have not had the expected results in lending to business in the UK, the hope is that “support for small and medium enterprises lending in Spain or Italy could have the same psychological effect as mortgage lending in Britain”. Ok guys, we all agree that we can not base our monetary policy on a hope, specially if this can result in adverse consequences of instability in the debt markets resulting precisely from new and a higher debt levels).
In the other hand, it is not appropriate to promote a Funding for Lending policy in the Eurozone until the AQR (Asset Quality Review) process has definitely determined the extent of the damage in the financial sector. A full recognition of bad debts and undercapitalization are aspects that, in my humble opinion, must be known before engaging is such a scheme.
In that regard, after banks sold an estimated €60bn in badly performing loans in 2013, a further €80bn is expected to be sold this year according to estimates by PricewaterhouseCoopers.
Once the AQR is completed (in October), the ECB could then unveil the Funding for Lending stimulus (I agree with Mr Andrew in this point). But this stimulus should be focused on the SME and industrial sector (not in the housing sector).
Thus, do not expect any large stimulus before. Until then, I fear that the euro will remain strong.
