After he steps down as European Central Bank (ECB) president at the end of October, Mario Draghi will be best remembered for the crucial speech he gave in the depths of the sovereign debt crisis in 2012, when he promised to do “whatever it takes” to save the euro. More recently, however, investors have been sharply focused on the fine print of the ECB’s much-anticipated stimulus package. 
Draghi and the ECB did not disappoint. The central bank unveiled a forceful stimulus package, surprising investors with an open-ended approach to another round of quantitative easing (QE) – asset purchases of €20bn per month will continue until inflation starts to rise. Using the ECB’s own forecasts for inflation, QE is likely to be in place at least until the end of 2020.
The policy rate was cut 10 basis points (bps) to -0.5 per cent and forward guidance strengthened where the ECB linked its rate and balance sheet policy more closely to inflation outcomes, signalling a renewed determination to reach the central bank’s 2 per cent inflation target. In addition, interest rates on existing lending operations were extended to three years and the interest rate lowered in line with the rate cuts.
Three factors spurred the ECB to act. First, there’s been the protracted slowdown in the eurozone economy. GDP grew at an annual pace of just 0.2 per cent in the second quarter of this year. Then there’s been the persistence of downside risks from sluggish growth in global trade, trade war concerns as well as the specific uncertainty surrounding Brexit. Third, we’ve seen a repeated undershooting of the inflation target and downward revisions in projected inflation, with the three-year ahead forecast now at 1.5 per cent.
Two interesting innovations arose from the meeting. There was the introduction of a tiered deposit rate, the first time the ECB has introduced such a policy. In what is likely to be Draghi’s last hurrah, the ECB is now allowing banks who exceed 6x their minimum reserve requirements to earn 0 per cent on these excess deposits. This gives them some reprieve by not applying the punitive negative deposit rate of -0.5 per cent.
The second innovation was the explicit passing of the stimulus baton to fiscal authorities, where Draghi basically signalled that monetary policy has reached its upper limits. In light of today’s environment, the ECB believes the eurozone economy would be better served by fiscal stimulus measures. Such measures would, arguably, help alleviate many of the challenges the eurozone economy currently faces.
The current easing package is unlikely to provide a boost to business and household spending. However, ECB stimulus should help reduce some of the downside risks arising from a challenging environment of trade wars, Brexit and a slowing Chinese economy. Moreover, by lowering funding costs, the stimulus should also make it easier for governments to finance fiscal expansion and nudge countries with some extra fiscal space to actually use it. Still, we do not expect that monetary stimulus alone will catalyse a sustained upside for economic growth or, by extension, equity earnings growth.
Banks will play a critical role in determining the European growth outlook, given financing remains primarily bank-intermediated (over 70 per cent of lending is done through bank loans). In recent years, negative deposit policy rates have been a drag on bank profitability and the spectre of more deeply negative rates in the ECB’s stimulus package has been a real concern. For this reason, many bank investors welcomed the ECB’s decision to “tier” bank deposits which subjects only a fraction of deposits to paying the negative deposit policy rate of -50bps. Previously, banks essentially paid the ECB about €7bn a year to keep €1.77trn worth of excess liquidity with the central bank (about 5-6 per cent of profits).
Tiering should offer some relief. Rough estimates suggest the net benefits from tiering and rate cuts amount to about 2 per cent of profits. The overall impact is small, and with policy rates likely to remain low and negative for the foreseeable future, the drag on bank net interest income remains a structural headwind to this sector.
In terms of asset market implications, the open-ended nature of the ECB’s QE and the extension of lending operations is supportive of peripheral sovereign markets and European credit. However, in the absence of fiscal stimulus, the ECB’s actions alone are not enough to lift the structural outlook for low European growth and low bank earnings growth over the medium term.
Thushka Maharaj is global multi-asset strategist at JP Morgan Asset Management. Rob Crayford. All views are her own and should not be taken as investment advice.