ECB offers plenty and cheap liquidity to support growth in all Eurozone countries

Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro (on the right), gave a joint press conference on the meeting of the G20 Ministers for Finance with Mario Draghi, President of the European Central Bank (ECB). (EC Audiovisual Services).

Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro (on the right), gave a joint press conference on the meeting of the G20 Ministers for Finance with Mario Draghi, President of the European Central Bank (ECB). (EC Audiovisual Services).

The rare and openly confirmed unanimity of European Central Bank’s Governing Council that interest rates should remain at their present or even lower levels for a long time, didn’t only gave a cause for celebrations in all European bourses, but it also induced some analysts to comment that Eurozone’s recession may be more persistent than many thought. This last possibility probably prompted Berlin to change its strictly austere stance. The basic interest rate of ECB remains at 0.5%. Let’s follow the facts.

ECB President Mario Draghi was unusually clear yesterday in his monthly Press conference which traditionally takes place after the policy setting meeting of the Governing Council. He confirmed that interest rates will remain low, and when pressed by journalist repeatedly asking for how long, he answered that this is not just for 6 or 12 months. He also clarified that the Governing Council took this decision unanimously.

To be noted that presently the Main refinancing operations interest rate is at 0.50 %. This is what the ECB charges Eurozone 6,000 banks for replenishing their liquidity. At the same time the Bank of England, the British central bank, announced also that its main interest rate remains at the present historically low-level of 0.5%. Actually the Governor of BoE commented that the markets were wrongly expecting an increase of interest rates soon. On top of that the BoE is about to embark on a government bond buying programme of £ 357 billion, thus supporting growth in the UK economy.

Guiding the markets

Mario Draghi however had more to say. He revealed that the Governing Council of ECB decided unanimously to change its policy in reference to ‘guidance’. Traditionally central banks do not ‘guide’ the market by revealing their intentions for future interest rates decisions. Governors give only vague comments about that. Now however this policy changes and Draghi was quite clear when he said that the current or lower interest rates will prevail in the long run and in any case much longer than a year. This is a clear guide for all markets.

In short Eurozone’s central bank decided yesterday a major change in its monetary policy. With inflation dangers well anchored below 2%, the ECB practically promised to support economic growth with cheap money and ample liquidity for all Eurozone banks for the years to come. It stopped short of buying government bonds, which is forbidden for ECB.

That was why stock exchanges all over Europe had a party yesterday. Stocks gained a lot yesterday and worries about politically stability in Portugal receded. The Pan-European index Stoxx Europe 600 gained 2.3% and the Euro Stoxx 50 of Eurozone went up by 2.95%. Deutsche Börse in Frankfurt gained 2.1%, the French CAC 40 went up by 2.90% and the British FTSE 100 was catapulted to 6,421.67 units 3.08% higher.

Support for those in need

Draghi went even further yesterday and reassured everybody that the ECB will make sure that there will always be enough liquidity in the system. He also reminded that “With regard to the Outright Monetary Transactions (OMT) programme, it is ready to be activated. The conditions are known and it is as effective a backstop as ever”. ECB’s OMT programme is a very strong weapon aimed at keeping down the borrowing cost of Italy and Spain. OMT proved quite successful because it did the job with not one euro having been spent. But let’s explain a bit what this OMT is about.

Last summer, amidst Eurozone’s last debt crisis, the Governing Council of the European Central Bank (ECB) announced that it decided the technical features regarding the Eurosystem’s OMT in the secondary sovereign bond markets. According to ECB’s Governing Council the aim was “at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy”. In this framework the ECB announced that it will intervene “with unlimited resources” in the secondary markets of national sovereign debt of all and every Eurozone country.

The official target was to safeguard the transmission of monetary policy to those national markets. In doing so however the ECB was promising at the same time, without saying it, that it will help Italy and Spain to borrow at low and sustainable interest rates. Only with cheap money Eurozone’s receding economy may regain the growth path.

Helping real economy grow however is not included in ECB’s mandate, unlike all other major central banks of the world. But seemingly its Governing Council thought that offering cheap money and more liquidity is the best way to support the inclusion of Eurozone’s south in the mainstream financial markets. This is ECB’s moral but also institutional obligation towards all member states of Eurozone, including Italy, Spain, Greece and Portugal. Until now Germany prevented the ECB from honouring this obligation. Seemingly Berlin cannot or does not want to support this stance any more. ECB will make sure that all member states of Eurozone have the same rights. At last monetary policy will not be any more a constraint but a growth brace.

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