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Central banks 07 Jun 2019

ECB delays rate hike, opens door to more accommodative measures

The European Central Bank (ECB) announced at yesterday’s meeting its future guidance on rates, which will remain on hold at least until the first half of 2020. As noted by BBVA Research in its ECB Watch report, the ECB is open to adopting further measures if necessary.  The ECB also announced the conditions of its TLTRO-III liquidity line.

The key point of interest of the ECB meeting held on Thursday was finding out to what extent would the European Central Bank be able to maintain its dovish tone, following the recent escalation of the trade conflict and the Fed’s willingness to cut interest rates. The other topic of interest of the meeting was the announcement of conditions of the new TLTRO-III liquidity auction.

According to BBVA Research’s report, the central bank exceeded expectations in terms of momentary policy by delaying the forward guidance on rates for six additional months. Thus, interest rates will remain on hold until at least through the first half of 2020. Although foreseeable, BBVA Research notes that the decision was not expected this early.

The central bank also reaffirmed its readiness to act in case of adverse contingencies with more expansive measures. In particular, Draghi openly recognized that “all possible measures have been debated, including lower deposit rates, restarting the asset purchase program (APP) or further extension in the forward guidance.”

Regarding the details of the new series of quarterly targeted longer-term refinancing operations (TLTRO III), Draghi stated that banks will have funding pressure to comply with regulatory requirements as well as the need to pay back the previous rounds, and the intention is that these operations will mitigate future “cliff effects”.

mario-draghi-bce-ecb-watch-reunion-tipos-politica-monetaria-bbva-research

Mario Draghi, President of the European Central Bank.

Regarding the cost, the interest rate will be set at 10 basis points above the average MRO rate over the life of each operation. For banks for exceeding their lending benchmark a lower interest rate will apply, which can be as low as the average deposit facility rate plus 10 basis points (-0.3 percent.)  This is cost is slightly lower than what BBVA Research analysts expected.

In the meeting, the ECB explained that Counterparties are entitled to borrow up to a total of 30% of the stock of eligible loans as at February 28, 2019, deducting any outstanding TLTRO II amounts. In addition, the amount that counterparties can borrow in each of the seven operations will be limited to, at most, 10% of their eligible stock. The ECB also explained that TLTRO III operations cannot be repaid before maturity (unlike TLTRO-II).  With this decision, the ECB ensures the avoidance of a “cliff effect” in new transactions.

On the economic outlook, Draghi stressed that the uncertainty is now higher and more protracted than expected in March, especially due to trade tensions, Brexit and vulnerabilities in the Global Economy.  BBVA Research considers that this situation could drive to more moderate growth in coming quarters and has lead the ECB to be ready to act if necessary.

This is reflected in the Staff Projections of a slight upward revision of GDP growth for 2019 (+0.1pp to 1.2%), but downwards for 2020 (-0.2pp to 1.4%) and 2021 (-0.1pp to 1.4%).  Risks to this scenario remain tilted to the downside.

All in all, the message from the ECB was more dovish than expected, as the ECB reacted to the increasing and prolonged uncertainty with a combination of a delay in the rate hikes and opening the door for further easing, concludes the ECB Watch report.

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