By Yoruk Bahceli, Dhara Ranasinghe and Ritvik Carvalho
LONDON (Reuters) – Having pared interest rates deep into sub-zero territory and pumped in 2.6 trillion euros worth of stimulus via asset purchases, the ECB may not have much left to give investors baying for more policy support.
Yet, as the coronavirus panic triggers recession alarm bells and slams stock markets, the focus has moved — yet again — on what the European Central Bank might do to support the economy. Pressure to act is also coming from inflation expectations, which fell on Monday to record lows.
But the ECB’s options are more limited than the U.S. Federal Reserve, which is expected to cut rates by a half-point this month. ECB policymakers have already expressed reluctance to ease policy but that has not deterred markets from pricing in a 10 basis-point cut in April.
And looks can be deceptive, some argue.
“One thing we learned through the crisis is that the ECB is the referee, rule maker and player; we should never underestimate what they can and what they’re willing to do,” said Piet Christiansen, senior ECB rates strategist at Danske Bank in Copenhagen.
Here are some options the markets are pondering. None are easy.
1. CUT RATES…SOON
Money markets fully priced in an April cut on Monday and attached a 90% probability to a March move, versus a 10% probability a week ago. They also priced in two full rate cuts by the end of the year. <ECBWATCH>
With rates already at a record low at minus 0.5%, further cuts may not help much, given the virus outbreak is not just cutting demand for goods and services but also affecting factories and other suppliers.
In fact, a cut could take the ECB closer to the so-called reversal rate — levels where monetary policy harms rather than benefits the economy; some reckon we are already there.
But cutting rates would have signaling power and would be easier to enact than other measures.
“It’s very clear that the first line of defense will be rate cuts,” said Michael Leister, head of interest rates strategy at Commerzbank.
(GRAPHIC: Euro zone money markets ramp up rate-cut bets – https://fingfx.thomsonreuters.com/gfx/mkt/13/2730/2695/Eonia0203.png)
2. TEAM UP
An ECB rate cut would pack more punch if it were part of a coordinated response from major central banks.
Central banks last joined hands in March 2011 when they intervened to stem the yen surge after the Japanese tsunami. There is no sign they are planning a repeat, even though the Bank of Japan said it would take necessary steps and the Bank of England said it was working with international partners to protect its economy.
“If you want to have the maximum impact from a rate cut, then co-ordinating that move with other central banks would mean shock and awe,” said Richard McGuire, head of rates strategy at Rabobank.
(GRAPHIC: Major central bank rates – https://fingfx.thomsonreuters.com/gfx/mkt/13/2726/2691/major%20central%20bank%20policy%20rates.png)
4. QE AGAIN
The ECB could boost its 20 billion-euro monthly asset purchases but there are hurdles, not least that the bank is approaching a limit on the amount of debt it can hold by each issuer.
Changing that would mean tweaking its rules; that’s opposed by many within the ECB. What’s more, things may not be bad enough to warrant additional purchases — for instance, even now credit and sovereign spreads – gaps between riskier and safer assets – remain relatively tight compared to history.
The Italian/German 10-year bond yield gap, would need to rise to 300 bps from the current 180 bps for the ECB to get seriously worried, analysts said.
(GRAPHIC: Italian-German spread, euro zone bank spreads climb on coronavirus fears – https://fingfx.thomsonreuters.com/gfx/mkt/13/2725/2690/spread.png)
4. BRING ON THE TLTROS
The ECB could beef up terms of its Targeted Long-Term Refinancing Operations (TLTRO) program which offers cheap bank loans and offer them as part of a package.
But the take-up of these loans has so far been lower than expected.
“What’s the point (of TLTROs) if the system is shut down and there is no demand for credit?” said Salman Ahmed, investment strategist at Lombard Odier.
5. TWIST GOVERNMENT ARMS
ECB Vice President Louis de Guindos on Monday said the front line of the response to coronavirus should be fiscal policy. Such calls will likely grow louder.
Germany is mulling tax breaks and a modification of its debt brake law to help local governments. But limits on federal debt accumulation remain in place. German 10-year bond yields <DE10YT=RR> last week notched up their biggest weekly falls since 2012 – clearly investors don’t expect significant fiscal stimulus soon.
(GRAPHIC: U.S., German yields hit lows – https://fingfx.thomsonreuters.com/gfx/mkt/13/2724/2689/yields.png)
(Reporting by Yoruk Bahceli and Dhara Ranasinghe, graphics by Ritvik Carvalho; editing by Sujata Rao and Philippa Fletcher)