ECB accentuates financial repression for an extended period

The ECB has lowered its deposit rate by 10bp to -0.5% and will keep all of its rates at the current level or lower until inflation converges to 2%. In the ECB’s forecasts, inflation will be 1.5% in 2021. Therefore, the short-term rates will remain at the current level until at least 2022.
The ECB has also decided to resume it Quantitative Easing program (QE) by 20 billions euro from November the 1st.. This has already resulted in a spectacular decline of the 10y Italian rate.
This QE measure will accentuate financial repression. The aim is to push the entire rate structure for all countries in negative territory, Italy included. It can last beyond what we imagine. The purpose of financial repression is to reduce the incentive to save and to increase the incentive to spend to curb activity on the upside.
The wish of the ECB is that fiscal policy will change and be more active so that the measures taken are more effective and faster. However, he has been repeating this since the beginning of his term.
The ECB will reduce its deposit rate to -0.5% with the adoption of a system that will adjust this rate according to the type of reserve (tiering). Excess reserves will be paid at 0% and the rest at -0.5%.
The TLTRO is extended to 3 years and the rate on each transaction will be the main refinancing rate over the remaining time of this TLTRO tranche.
Given the length of the TLTRO and the expectations mentioned above on inflation, the applicable rate could be on average the deposit rate over the duration of the transaction for banks whose loans exceed the loan reference defined by the ECB. This means that for banks with excess liquidity, they may have an interest in lending and placing their loans in excess reserves. This will strengthen the banking sector.

The financial repression put in place by the ECB implies that interest rates for all maturities and for all countries are low and negative for a very very long time.
Economic players have changed their behavior when interest rates dropped to 0 or negative. But this change is now over. Behavior’s change will be marginal. The upward macroeconomic impact will therefore be very limited.
Moreover, the ECB’s signal could also be interpreted as reflecting a particularly degraded situation, thus raising concern for households and companies. Th risk is that signal may, at the end, have a negative effect on the economy. Will the stronger banking sector be enough to counteract this effect? It’s an unknown today.
Growth forecasts are revised downwards to 1.1% in 2019, 1.2% in 2020 and 1.4% in 2021. An external shock could tip the Eurozone into recession. For now, the ECB considers this probability to be very low.
This nonetheless reinforces the need for an effective and proactive fiscal policy to get out of the current liquidity trap whether or not there is a recession.
Given the lack of willingness of governments to have a coordinated fiscal policy, the position of Draghi is associated with a strong bet on the future at the risk of becoming wishful thinking.
Good luck Christine Lagarde

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