The ECB failed – or did it?

Mario Draghi gave the market a big surprise yesterday, going way beyond what the market had expected. Has he screwed up? John Stepek looks at what he said.


ECB: has it done enough to convince the market?

So now we know.

Mario Draghi, central banker extraordinaire, opted to give the market a big surprise yesterday.

The European Central Bank (ECB) governor went way beyond what the market had expected in terms of money-printing and mad scientist monetary policy.

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And yet the euro ended the day much higher than where it began.

Has Draghi screwed up?

Here's the deal you borrow enough money from me, and I'll pay you

First off, he decided to print more money. The ECB will no longer buy €60bn a month of bonds. It's jacked that up to €80bn. Not only that, but now it's going to buy investment-grade corporate bonds too.

That's exciting enough for markets. But Draghi didn't stop there. Oh no. He cut the main eurozone interest rate to 0% from 0.05%. OK, that's not such a big deal.

But he also cut the ECB's deposit rate to -0.4% from -0.3%. That means it'll cost banks more to leave money with the central bank.

However, he craftily dodged the mistake that the Bank of Japan made. You see, if you want banks to lend out money, you don't want to squash their profit margins particularly if your banks are bust (which eurozone banks are).

So Draghi also made more funds available for banks to borrow at negative rates "essentially paying eurozone lenders to increase credit to households and companies", as the FT puts it.

He did this through another bout of "targeted longer-term refinancing operations" (TLTRO). Basically, banks will be able to borrow money at 0% for four years, from the ECB from June. They'll be able to borrow up to 30% of their existing loans.

Then, reports the Daily Mail, in two years' time, if the ECB finds that the bank is lending 2.5% or more than it was previously, "the ECB will pay them up to 0.4% of what they borrowed".

As Draghi put it: "a bank that is very active in granting loans to the real economy can borrow more than a bank that concentrates on other activities".

A lot of people did the usual dismissive thing of saying: "Oh this doesn't matter".

I'm not so sure. Imagine if your mortgage was -0.4%. You could make a monthly payment of £0 and the amount of capital outstanding on the loan would still fall.

Even thinking about that spins my head around a little, and I'm fairly used to dealing with central bank madness.

If, as a bank, you can borrow money from the ECB at a negative interest rate, then technically, you could lend it out at an incredibly low rate, and still make money. In fact, you could even pay customers to borrow from you.

All you'd need to do is to make sure that you're paying them less than the ECB is paying you, and you've still made a margin on the deal.

It wouldn't have to be something as weird sounding as a negative interest rate. Instead, you could dish out cashback of some sort.

I'm not saying that'll happen why would you lend to someone at negative rates unless you had to? But the mind boggles.

Forget whatever it takes, I've done enough

After unleashing monetary havoc on the eurozone, and no doubt making the German central bank governor neck a tumbler-full of blood pressure pills, Draghi reined it all in.

"Does it mean we can go as low as we want without having any consequences on the banking system? The answer is no." He continued: "From today's perspective, we don't anticipate it will be necessary to reduce rates further".

That seemed a bit silly. The market pretty much took that as a reversal of "whatever it takes". The euro ended the day higher against the dollar.

But let's think about that again.

Yesterday I noted that Draghi was keen to see a weaker euro, because it was the only way he could do anything to help the more fragile economies in the eurozone.

But after what he pushed through yesterday, I'm not quite so sure.

He's managed to turn interest rates negative. But rather than just use it as a stick to beat the banks with, he's given them a pretty hefty carrot too, to encourage lending.

He revised down the growth and inflation figures to exceptionally gloomy levels, laying the ground to justify future intervention if necessary.

And he managed to accelerate the money printing that he's doing (which is no surprise as James Ferguson of the MacroStrategy Partnership has pointed out in the pages of MoneyWeek countless times, eurozone banks are way behind everyone else in terms of being "fixed", and that's why the ECB will need to print money for far longer than most people expect).

In short, he's done a lot.

And if you think about it in that light, you could interpret a rise in government bond yields particularly German ones, the safest of the safe, as far as the eurozone goes and a rise in the euro, in an altogether different way.

That increase may not be because the market doesn't think he'll do enough. Maybe just maybe the reality is that Draghi has now done enough to convince the market that the eurozone isn't set to topple into a deflationary pit from which it shall never emerge.

We'll see.

By the way, if you find all this monetary jiggery-pokery a little unnerving (I know I do) then you should sign our petition against something even more radical a ban on cash. We're very nearly at the 10,000 we need to get a response from the government, but the deadline is approaching fast. If you haven't signed it already, please do.

And if you have, let your friends know.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.