Economic Insights European Central Bank (ECB) President Mario Draghi’s latest comments fire up risk currencies

Economic Insights

European Central Bank (ECB) President Mario Draghi’s latest comments fire up risk currencies

Global risk assets from equities to currencies and from commodities to High Yield (HY) bonds received a boost after the comments from Draghi who said that the firewalls were ready and it would be better than the past. He also said that the central bank was ready to act whatever needed to preserve the currency bloc.

On the day before Draghi’s comments, ECB council member Ewald Nowotny mentioned an argument in favour of granting the European Stability Mechanism (ESM) a banking license.

More voices from Spain and Italy will ask for sovereign assistance in the next few days and the Citigroup has forecast an increased possibility of “Grexit” to happen within 12-18 months.

Draghi did not reveal any kind of details, whether it will be negative interest rate on the ECB’s deposit, restarting the Securities Markets Program (SMP) programme, Long-term Refinancing Operations (LTRO) III, Very Long Term Refinancing Operation (VLTRO) or transform the ESM into a bank. But the reaction yesterday was mainly because investors had given up on more measures from the central bank because the governments needed to act first. That was the main theme we heard from Draghi’s press conference.

I believe that it was the recent Spain and Italy’s high borrowing costs that triggered the comments. So far there is no evidence that shows the ECB is going to act or going to do. Let’s not forget that Germany has not commented anything so far.

Source: Reuters

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There are limits to what ECB can do

If the central bank is going to act beyond the words, restarting the SMP and granting the ESM a banking license could be the most possible measures. The main objective of the SMP is to ease tension in the debts market and lower the borrowing cost. The ECB has bought more than EUR 225 billion bonds since 2010.

However, similar to the LTROs, the SMP has its limitations such as unable to attract private investors to buy the sovereigns securities, which is the key factor to drive the interest rate to fall in a sustainable pace, instead of offering the private sector’s investors a chance to square the positions by taking advantage of the intervention.

Regarding the ESM to be granted a banking license, the main concern is still the limitation of the fund size. If it aims to rescue a much larger economic scale countries such as Spain and Italy, although they can directly access the ECB’s repos. Besides that, it will involve monetisation of the public debts, then which could be opposed by Germany.

The least effective way could be the interest rate cut on the ECB’s deposit into negative, which aims to make banks to lend more. However, the rising debts will certainly deteriorate the credit demand in the region no matter how cheap the loan is. The figures has shown that the demand for business loan, mortgage loan and personal loan has declined near to the level in crisis period in 2008; and this strategy certainly contradicts the views on lowering the budget deficit highlighted by Germany and reduces the effort to reform.

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