Friend and foe of the chairman of the European Central Bank
(ECB) agreed that Mario Draghi finally deployed his ‘bazooka” during his 5
June statement on behalf of the ECB:
Draghi: First, we decided
to lower the interest rate on the main refinancing operations of the Eurosystem
by 10 basis points to 0.15% and the rate on the marginal lending facility by 35
basis points to 0.40%. The rate on the deposit facility was lowered by 10 basis
points to -0.10%. These changes will come into effect on 11 June 2014. The
negative rate will also apply to reserve holdings in excess of the minimum
reserve requirements and certain other deposits held with the Eurosystem.
Second, in order to
support bank lending to households and non-financial corporations, excluding
loans to households for house purchase, we will be conducting a series of
targeted longer-term refinancing operations (TLTROs). Counterparties will be
entitled to borrow, initially, 7% of the total amount of their loans to the
euro area non-financial private sector…
In addition, from
March 2015 to June 2016, all counterparties will be able to borrow, quarterly,
up to three times the amount of their net lending to the euro area
non-financial private sector, excluding loans to households for house purchase,
over a specific period in excess of a specified benchmark. Net lending will be
measured in terms of new loans minus redemptions. Loan sales, securitisations
and write-downs do not affect the net lending measure. The interest rate on the
TLTROs will be fixed over the life of each operation, at the rate on the
Eurosystem’s main refinancing operations (MROs) prevailing at the time of
take-up, plus a fixed spread of 10 basis points. A number of provisions will
aim to ensure that the funds support the real economy.
Third, the Governing
Council decided to intensify preparatory work related to outright purchases in
the ABS [asset backed securities – EL] market to enhance the functioning of
the monetary policy transmission mechanism. Under this initiative, the
Eurosystem will consider purchasing simple and transparent asset-backed
securities with underlying assets consisting of claims against the euro area
non-financial private sector
Fourth, in line with
our forward guidance and our determination to maintain a high degree of
monetary accommodation, as well as to contain volatility in money markets, we
decided to continue conducting the MROs [main refinancing operations – EL] as fixed rate tender procedures
with full allotment for as long as necessary, and at least until the end of the
reserve maintenance period ending in December 2016.
Furthermore, we
decided to conduct the three-month longer-term refinancing operations (LTROs)
to be allotted before the end of the reserve maintenance period ending in
December 2016 as fixed rate tender procedures with full allotment. The rates in
these three-month operations will be fixed at the average rate of the MROs over
the life of the respective LTRO.
Turning to the
monetary analysis, data for April 2014 continue to point to subdued underlying
growth in broad money (M3). Annual growth in M3 moderated further to 0.8% in
April, from 1.0% in March. The growth of the narrow monetary aggregate M1
moderated to 5.2 % in April, after 5.6% in March. In the recent past, the
increase in the MFI net external asset position, reflecting in part the
continued interest of international investors in euro area assets, has been the
main factor supporting annual M3 growth.
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| Chart of the M1 and M3 money supply in the Euro-zone Chart by: Ernst's Economy for You Data courtesy of: ECB Click to enlarge |
Draghi: The annual rate
of change of loans to non-financial corporations (adjusted for loan sales and
securitisation) was -2.7% in April 2014, compared with -3.1% in March. Weak
loan dynamics for non-financial corporations continue to reflect their lagged
relationship with the business cycle, credit risk and the ongoing adjustment of
financial and non-financial sector balance sheets. The annual growth rate of
loans to households (adjusted for loan sales and securitisation) was 0.4% in
April 2014, broadly unchanged since the beginning of 2013.
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| Loans supplied by Credit Institutions in the Euro-zone in Millions of Euros Chart by: Ernst's Economy for You Data courtesy of: ECB Click to enlarge |
There is almost no arguing that the Euro-zone seems at the
brink of prolonged (?) deflationary times.
First, one should consider that the Euro-zone has expanded with no less than five countries, since January 2008: Cyprus, Malta, Slovakia, Estonia and Latvia.
With that in mind, one only has to look at both aforementioned charts, to see that the available broad money supply 'M3' and the outstanding credit from credit institutions in fact have tightened in the Euro-zone, during the last few years. Especially the loans supplied by Credit Institutions have plummeted since the second quarter of 2012.
The fact that a substantial expansion took place within the Euro-zone can hardly be recognized in the aforementioned charts. This is a
tell-tale signal of the ongoing deflationary impulses, in my humble opinion.
As Draghi probably agreed with these impressions, he pulled his bazooka
out of the closet… Summarizing, this ‘bazooka’ consists of four different measures:
- Lowering the refi-rate by another 0.1% and penalizing excess bank deposits at the ECB with a negative interest rate of -/- 0.1% (First measure);
- Deploying new, massive lending facilities for households and non-financial corporations (Second measure);
- Supplying the banks with money against “plain-bread-and-butter collateral” (Third measure);
- Making sure that this money can be borrowed for a prolonged time at extremely favourable rates (Fourth measure).
You can argue about the answers to the questions, whether
these four measures are sensible or not AND whether these measures will have
the desired effects of:
- a. increasing the money flow from the banks to private
households and Small and Medium Enterprises (SME);
- b. rising the inflation rate in the Euro-zone after all.
Personally, I am not convinced that these measures by Mario
Draghi will actually have these desired effects.
Lending to SME company is
still a risky and even unprofitable business for many banks, in spite of the
considerable spreads between the funding costs of loans and the actual interest rates,
charged to the customer.
Here is a quote from a
recent statement by Wilfred Nagel, Chief Risk Officer at Dutch SIFI bank ING
Bank:
Many factors determine
the customers that a bank lends to within the scope of its balance sheet,
including the nature and duration of the relationship with the customer, the
risk profile of the proposed loan, the price the bank receives for taking on
risk, the extent to which the loan contributes to the creation of concentration
risk on the balance sheet and the requirements of the sustainability policy
being pursued.
The importance of
proceeding carefully in this respect, is underlined by recent experiences with
lending to SMEs. Dutch SMEs made up 5% of ING’s total credit portfolio in 2013
but contributed 22% of the total addition to the reserve for loan losses.
Against this
background, the question is what actual public interest is served by loosening
credit standards applied to SMEs? And how does this relate to the aim of safer
banks? In fact, banks are now being told to stretch their approval criteria,
which is the same as calling for more financing (often of losses) and expansion
instead of reducing SMEs’ dependence on debt.
While Mario Draghi’s measures will definitely reduce the funding
costs for banks, which are lending to SME companies, these measures will not reduce the risks
involved in such loans.
The reason for this is, that the lender's risk is mainly positioned at the demand-side of
these SME businesses: most problems for SME companies and (especially) retailers are caused by the ubiquitous consumer
strike, which is still ongoing at the moment.
From my own experience at the Business Lending department of a Dutch multinational bank, I know that it was mainly the risk component, which
made SME lending an unprofitable business during the last few years. Not the
funding costs or the narrow interest spread of such a loan...
Nevertheless, the one thing that you hardly couldn’t argue
about in the prelude to last week’s statement, was Mario Draghi’s unspoken obligation
‘to do something’!
Draghi had to act, in order to show the world that he meant
business, with his battle against especially the looming risk of deflation and –
more generally – the prolonged economic crisis in the Euro-zone.
In the past
months, Draghi had so often announced that he would act decisively when the inflation
rate would keep on dropping, that the whole financial world – and Draghi himself
– felt that the ECB would lose all credibility, had Draghi again stuck with ‘words
and warnings’ in June.
And now Draghi’s bazooka should force the banks to lend more money at
especially private households and SME companies
– almost at-gunpoint.
Draghi hopes (probably against his better judgment ) that
these measures will be effective, where previous measures with respect to the
interest rates and the money supply all failed, for the reasons earlier described by
Wilfred Nagel of ING Bank.
With the following charts, based on data from Eurostat, I
will show that the risk of deflation in the Euro-zone is not an imaginary risk,
but a very vivid one.
The inflation trend is definitely pointed downwards for almost all categories of household and corporate spending:
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| Inflation in the Euro-zone from 2011 - 2014 Category: Food Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Non-alcoholic Beverages Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Clothing and Footwear Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Transport Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Education Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Communication Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Furnishing, household equipment and routine maintenance Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Health Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Housing, water, electricity, gas and other fuels Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Miscellaneous Goods Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Recreation and Culture Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
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| Inflation in the Euro-zone from 2011 - 2014 Category: Restaurants and Hotels Chart by: Ernst's Economy for You Data courtesy of Eurostat Click to enlarge |
Last Saturday, the well-known Dutch economist and columnist Mathijs
Bouman wrote a
thought-provoking column about Draghi’s bazooka.
Bouman argued that Draghi
had not been fighting against the phenomena ‘deflation’ last Thursday, but
against the high interest rates that banks charge to their customers (for the
reasons I described earlier in this article).
He might actually have a point
there…
Nevertheless, concerning the high interest rates that banks
charge to their customers, I stated earlier that banks are forced too do so and not simply overcharge customers at will. Banks have no other option then to cover their substantial losses on SME loans gone awry. However, Bouman
does not take this into consideration at all in his column.
Besides that, in this column Mathijs Bouman tried to
downplay the risk of deflation with a simplified example.
Here are the pertinent snippets of this column:
Nobody postpones his
purchases, as a consequence of a dropping general price level – which is what
we talk about with the expression ‘deflation’.
This is actually useless. Think of this: "I don’t buy green beans, as they will be cheaper tomorrow. Tomorrow I won’t buy
them again, as the price will drop further again the next day. In the end, I
will never buy green beans anymore. And as my shopping cart will become cheaper
every day, I will never buy something anymore".
Whoever speculates on price
drops for eternity, will die of starvation.
Although I sympathize with Bouman’s argument, I personally think
that he mixes up cause and effect in his column.
People will not consume less (effect), due to deflation
(cause)… Instead, deflation (effect) will continue, because people consume less for a prolonged period of time (cause)!
And of course this is not so much true for necessary, daily consumption
goods and foodstuffs, like greenbeans or bread, as people need to eat after all: this makes Bouman’s example so ridiculous
and over-the-top.
However, I am certain that in recent years there has been a
clear shift from more expensive foodstuffs and daily consumption goods, towards
cheaper food and articles. This shift will definitely have caused deflationary impulses. It is not a coincidence that discount supermarkets,
like Lidl and Aldi have been the absolute winners of this crisis, at the
expense of the more expensive supermarket chains!
Besides that, this shift did also take place in the general consumption of luxury goods and durable
household appliances:
People still buy these goods – when they need them or
really want them -, but they buy them only at the lowest possible price. And when such purchases can be avoided, they will be skipped at this very moment.
This is the
reason that many chains for household appliances and small electronics have
perished, during the last few years, while the remaining chains are involved in
an enduring race-to-the-bottom for prices. Draghi's bazooka won't help this effect.
And the worst danger of deflation is – in my humble opinion –
that it can lead to an enduring, negative wage/ price spiral and restrained
consumption for many years.
Many companies cannot afford to pay higher wages to
their personnel at this very moment and the companies that can afford it,
simply don’t do that…
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