Thursday, February 6, 2014

ECB Day: Coup de théâtre?

ECB board members meet today. As shown in the following graphs overnight interbank rate (EONIA, 1st graph*) presents great volatility upon Emerging Economies' capital outflows, Eurozone inflation declines (blue line, 2nd graph*), and recent developments do not leave much space for optimism. 

Reuter's Paul Carrel examines the available policy tools of ECB, but which one would be the most probable? The board will surprise me (a lot) if they decide to suspend Sterilization operations and to proceed to aggressive QE, which are rather unconventional. The other three policy responses, namely forward guidance, cutting rate (currently at 0.75%) and LTROs at low rate are much more likely (and convnetional) to happen. P. Carrel also mentions negative deposit facility rate; an innovation. So, no marvel for now! (I might be wrong though, as previously - do not bet any money!!!!)

Apart from interbank lending which will become cheaper and somewhat less volatile upon today's most probable monetary policy decisions, commercial and consumer lending shall not be facilitated at all. Here is one reason why. If you were a banker, would you lend me more, because you would have low-cost access to liquidity or because you are expecting me to pay you back? What happens if my ability to repay my debts depends on my (expected) future income, which, in turn, depends on my clients' ability to buy my products/services, with the latter depending on their income, and so on? Taking under consideration the recent Eurozone developments - i.e. decreasing investment and retail volume, 0.7% inflation, 12% unemployment - it becomes less and less probable for many households and small and medium sized businesses to maintain their ability to pay off their lenders. So banks avoid lending because of default risk subject to Eurozone outlook, and, perhaps, the pool of solvent entities demanding more lending has drained.

So, this is a liquidity trap and monetary policy has no effect, other than on interbank lending. Austerity, goes on... Aggressive QE would be optimal, allowing governments to borrow at low cost, to fuel growth and then start taming their deficits and debts while their economies flourish. Perhaps, some other time and with another ECB mandate! Until then, a farewell to... recovery!

*Source: ECB Statistical Data Warehouse