The month of September turned out to be one of synchronised global monetary stimulus. The European Central Bank (ECB) re-opened the monetary spigot, delivering a multi-faceted expansionary policy at the September meeting of the Governing Council. The strategy includes a reduction in the deposit rate by 10 basis points, from -40 basis points to -50 basis points, effectively increasing the cost levied on overnight bank deposits.
With no rate cuts since early 2016, the objective is to push European banks to lend more. However, the initial introduction of negative rates has not resulted in increased lending. To curb the impact on bank profits, ECB president Mario Draghi also announced the introduction of a tiered deposit rate, whereby bank deposits exceeding six times mandatory reserves will be exempted from this levy.
The ECB’s plan also includes the reintroduction of its quantitative easing programme in November, with the purchase of 20 billion euros in bonds per month for the foreseeable future, or at least until shortly before the first rate hike. The expansionary package also allowed for easing the terms on TLTROs (Targeted Long-Term Refinancing Operations), the mechanism whereby the ECB lends cheap money to banks for multiple years in the hopes of spurring increased lending activity.
The ECB was not the only central bank taking a more accommodative stance in September. On the other side of the Atlantic, the Federal Reserve (Fed) cut its benchmark rate by ¼ point – the second cut in two months – citing undesirable global developments and a lack of inflationary pressures. Although both the Fed and the ECB have injected stimulus into their economies the effectiveness of such actions has been mixed.
Having just completed a three-year monetary-tightening cycle, the Fed still has some room to ease further if necessary. Although the ECB and the Fed both embarked on quantitative easing programmes after the financial crisis, Europe has not experienced the same recovery as the US. Despite years of monetary easing, the ECB has struggled to revive growth and attempts to achieve its 2% inflation target seem futile. Now, with the current negative yielding environment the ECB has far less leeway than the Fed to withstand a decline in economic growth.
Some argue that the dismal growth and inadequate economic recovery of the Eurozone is a direct consequence of the structure of the European Union and the objective of the Eurozone’s central bank. The US has the ability to cut interest rates, which can help to devalue its currency to help increase net exports, as well as increase fiscal spending, if needed. However, the Eurozone has primarily had only one lever at its disposal; monetary policy on behalf of highly disjointed economies.
Trying to set monetary policy for 19 countries with distinct economies and fiscal policies in the hopes of stimulating growth across the EU is beyond challenging. Germany, an export-driven economy and generally seen as the most important economy in the Eurozone, is currently experiencing a recession in its manufacturing sector. That does not bode well for the rest of the EU. Likewise, the fiscal situation across the member nations calls for different strategies among the currency bloc. Germany has more-than-sufficient capacity to finance fiscal stimulus and endure a budget deficit, especially amid an economic slowdown in the bloc, whereas a country like Italy has less capacity to borrow and therefore needs to manage budget deficits better while continuing to implement structural reforms.
The ECB’s announcements came at a time when the Eurozone economy faces increased risk of a recession due to a manufacturing slump and dampened business sentiment as a result of Brexit and the US-China trade war.
Many are calling for fiscal stimulus to step in as monetary policy seems to be reaching its limit. Yet, any plans to take a step closer to a fiscal union will likely face significant opposition from fiscally conservative member states and, despite all the willingness in the world, the ECB does not have the authority to make this a reality. Undoubtedly, with monetary policy sapped, it’s time for fiscal policy to come to the rescue.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.