The monetary easing announced by the European Central Bank on Thursday had some unexpected components, in particular the new ‘TLTROII’, but it is unlikely to provide a significant boost to the subdued eurozone recovery, Fitch Ratings says. This assumption is reflected in our latest eurozone growth forecast, which sees the bloc’s real GDP expanding by 1.5% for the second consecutive year in 2016.
The ECB cut its deposit rate by 10bp to minus 0.4% and expanded its quantitative easing programme, increasing monthly purchases to EUR80bn and including investment-grade corporate bonds. Cuts to the deposit rate and QE expansion were in line with our expectations, but the ECB also cut the main refinancing operation (MRO) rate by 5bp to zero. We had forecast that the MRO would be unchanged.
Four targeted longer-term refinancing operations (TLTRO II) will start in June. Borrowing rates on these four-year facilities could be as low as the interest rate on the deposit facility, if banks exceed certain lending benchmarks.
The ECB’s action has no impact on bank ratings. Very low interest rates are already making it more difficult for banks in the eurozone to sustain profitability and return on equity remains well below pre-crisis levels. Net interest margins are unlikely to see a material improvement until either competition eases or more banks pass on negative rates to their customers. Most are reluctant to consider this, but the longer the period of negative rates continues, the more earnings come under pressure.
We do not believe Thursday’s measures will have a major additional impact on banks’ profits or their willingness to lend. Taken as a whole, at EUR200bn at end-2015, eurozone commercial banks’ excess reserve deposits at the ECB are still a small share (0.7%) of their total assets. Even if they rose to EUR500bn due to QE, and the deposit rate were cut further to minus 0.5%, the annual cost to the eurozone banking sector would be EUR2.5bn, or around 5% of its total 2015 profits. Similarly, taking the MRO 10bp into negative territory would have an annual cost to the sector of around EUR0.5bn via remuneration on required reserves.
The impact on banks will vary. Those with customer deposits and long-term funding that exceed their opportunity to extend lending at viable rates of return are more exposed than those whose loans-to-deposits and long-term funding ratios remain above 100%. The former are more likely to charge for customer deposits or impose negative rates. The availability of cheap funding via the TLTROs would benefit participating banks’ net interest margins if earnings are not dragged down by surplus funding and liquidity, and they are able to extend TLTRO funding to lend at reasonable margins, taking risk into account.
The existing stock of floating-rate lending at rates linked closely to central bank rates will be a drag on earnings and the benefits of long-term fixed rate loans priced when ECB rates were higher will erode if low or negative central bank rates persist and higher rate lending is repaid.
The ECB expects inflation to remain negative in the coming months before picking up later this year. We think its willingness to loosen monetary conditions to keep long-term inflation expectations anchored is one reason the eurozone can avoid prolonged deflation. However, the market moves following the announcement and ECB president Mario Draghi’s subsequent comments highlights the potentially volatile reactions to central bank communications, which can have an impact on the effectiveness of policy measures.