« ECB cuts its key rate by 25bp, leaves interest rate corridor unchanged
The ECB Governing Council cut its main refinancing rate by 25bp to 0.75% today, in line with economists’ expectations. Contrary to our forecast, the ECB also cut its deposit rate by 25bp, taking it to a record low at zero. Draghi said that the cut was intended to improve confidence and encourage investment. He acknowledged, however, that elevated financial market tensions have weakened the monetary policy transmission channels, dampening the impact of a rate cut on the real economy.

Draghi reluctant to admit ineffectiveness of LTROs, but highlights credit problems 
Draghi reiterated that we cannot expect LTROs to have an immediate impact, and stated that the channelling of funds to the real economy via banks is difficult to implement. He attributed subdued loan growth to heightened risk aversion, ongoing private deleveraging and weak credit demand. Draghi said the ECB has done a lot to ease banks’ liquidity conditions including the enlargement of the collateral asset base, to encompass collateralised loans. He expects this measure to incentivise banks to lend to the real economy as this lending could be funded by the ECB. We consider this argument fundamentally flawed as banks cannot make long-term loans based on short-term liquidity. Hence, even though collateral requirements have eased considerably, the relatively short-term maturities of ECB liquidity provisions could limit the positive impact on lending.

ECB worried about monetary transmission through banks, door open to further action 
Draghi’s repeated emphasis on the fragmentation of credit conditions in the eurozone suggests that the ECB is worried about the credit crunch in peripheral countries. In view of this, we think the ECB has scope for another 25bp rate cut before year-end. The ECB could also continue to loosen collateral requirements in order to ease conditions (Draghi left the door open to this today), and could even decide at some point to lend on an uncollateralized basis to banks. Should loan growth remain poor even after such steps, the ECB would be forced to consider other options to further ease financial conditions. In our view, it could do this by directly purchasing corporate credit portfolios from banks. We thus believe that the focus of ECB policy later in the year is likely to turn to more direct credit easing measures. »

Celui de Citi:

« The ECB cut the main refinancing rate by 25BP to 0.75%, as widely expected. The ECB also cut the rate of the marginal lending facility by 25BP to 1.5% and the rate on the deposit facility by 25BP to 0.0%. According to President Mario Draghi the rate decisions were “unanimous on all grounds”. The ECB maintained the stance of all non-standard measures and, according to Mr. Draghi, the Council has not discussed additional LTROs or collateral changes today.

-President Draghi explained the rate cut with dampened inflationary pressure, “as some of the previously identified downside risks to the euro area growth outlook have materialized”. The ECB still expects the euro area economy to recover gradually (according to Draghi around the end of the year), but added that this outlook would be surrounded by downside risks.

-According to the ECB President, the rate cuts would reduce the funding costs of banks, as it would apply to all open market operations of €1.1 trillion. He added that the reduction of the deposit rate to zero would have been taken to ensure that the rate cut feeds through into market pricing. As there would be little upside risks on inflation expectations in the current environment, he did not see risks emerging from having the deposit rate at zero. According to Mr. Draghi, the ongoing and likely persistent weakness of credit demand would continue to undermine the transmission of the interest rate signal. While Mr. Draghi dismissed signs of deflation in the euro area, he highlighted that the ECB has enough policy tools to defend its price stability mandate in both directions. While, as usual the ECB never pre-committed to future policy, the ECB President did not rule out cutting interest rates further, including a negative deposit rate.

-On the non-standard measures the ECB made clear that some banks would face bottlenecks of eligible collateral. Regarding the 3Y-LTRO, he said that it would be still too early see the full impact of the liquidity provision, adding that the measures would not be fully effective in the current fragmented environment.

-The ECB welcomed the outcome of the EU Summit. While not giving details on the potential role for the ECB as a single supervisor, Mr. Draghi said that the ECB is keen to take-on the new responsibility as a separate function to monetary policy. The ECB would be also ready to accept higher levels for democratic accountability.

Comment: While we expected the 25BP cut of the refi rate, the ECB surprised us with its unanimous decision to set the deposit rate to zero. We expect that more downside risks to the ECB’s still benign growth outlook will materialize and that the sovereign and banking crisis will escalate further. Therefore, we continue to expect the ECB to cut the refi rate to 0.5% and we now regard a negative deposit rate of minus 0.25% as possible. But unless there is a sharp fall in activity data in July, such rate cuts are unlikely before September. Although, not being discussed today, we continue to expect the ECB to take further non-standard measures, including easier collateral rules and more multi year LTROs – maybe as early as August. »