A policy shift by the ECB seeks to curb disinflation before it gets out of hand.
The European Central Bank (ECB) took decisive steps on Thursday to support the economy and counter deflationary forces in the eurozone. The central bank lowered its benchmark interest rate to 0.15% from 0.25%, and also reduced its deposit rate below zero, to -0.1%, which will encourage banks to lend rather than park funds with the central bank. In addition, it is planning liquidity injections via targeted long-term refinancing operations (TLTROs) and will end SMP sterilization, which involved withdrawing euros from banks in amounts equal to what it was spending to purchase government bonds. Overall, we believe the combination of negative rates and rich liquidity should support performance in peripheral markets, lead to steeper yield curves and lower the euro exchange rate.
TLTROs with Clout
While it is difficult to judge how much liquidity the TLTROs will actually inject, we believe the amount will be significant. Banks could inject as much as EUR 400 billion in total on the two initial TLTROs, equal to 7% of total loans to the non-financial private sector (excluding loans to households). We believe it will be commercially attractive for any bank in the euro system to get up to four years' funding at a fixed rate of 0.25%.
Currency Is Key
Importantly, the ECB action is an effort to reduce the value of the euro, which, along with commodity price weakness, has been a key source of disinflation in Europe. Historically, the ECB has been reluctant to take aggressive measures until the data forces its hand, which has contributed to euro strength given looser monetary conditions in other regions. Although, in some ways, financial and economic conditions have greatly improved over the past couple years, the inflation rate has declined to uncomfortable levels last seen when the ECB intervened two years ago. While the ECB has successfully "talked down" the euro from its highs in May, we think these moves will provide further momentum for decline.
Investment Impact
In our view, the measures bode well for corporate credit conditions, in particular those of small and medium-sized businesses, which were a focus of the ECB action. (Large European corporations are typically very well capitalized and have good access to lending.) Looking at particular markets, we believe that German longer-term sovereign bonds may be vulnerable, given the potential for faster growth and inflation. In general, G-3 government bonds provide little upside given their low yields.
In contrast, we see some potential in peripheral European markets. Yields in Italy and Spain have reached new lows, benefiting from a positive rating cycle, good carry and rapidly improving fundamentals-which are likely to remain in place.
Future Measures Likely 'Unconventional'
It will take time for the macro implications of the ECB's actions to become apparent. Therefore, we do not expect further measures from the ECB for now, although the central bank stands ready to act, if needed. With inflation well below its target, the ECB will react to any significant rise in the euro. As ECB President Mario Draghi pointed out, each 10% exchange rate depreciation increases inflation by around 50 basis points. So the ECB must maintain, and preferably further amplify, recent weakness in the euro. With guidance now that rates will remain at present levels for an extended period, further action will not be on rates, but will be via unconventional measures.
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This material is not intended as a formal research report and should not be relied upon as a basis for making an investment decision. The firm, its employees and advisory clients may hold positions of companies within any sectors discussed. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. This material may include estimates, outlooks, projections and other "forward-looking statements." Due to a variety of factors, actual events may differ significantly from those presented. Investing entails risks, including possible loss of principal. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
This material has been issued for use by the following entities; in the U.S. and Canada by Neuberger Berman LLC, a U.S. registered investment advisor and broker-dealer and member FINRA/SIPC; in Europe, Latin America and the Middle East by Neuberger Berman Europe Limited, which is authorised and regulated by the UK Financial Conduct Authority and is registered in England and Wales, Lansdowne House, 57 Berkeley Square, London, W1J 6ER, and is also regulated by the Dubai Financial Services Authority as a Representative Office; in Australia by Neuberger Berman Australia Pty Ltd (ACN 146 033 801, AFS Licence No. 391401), which is licensed and regulated by the Australian Securities and Investments Commission to deal in, and to provide financial product advice for, certain financial products to wholesale clients; in Hong Kong by Neuberger Berman Asia Limited, which is licensed and regulated by the Hong Kong Securities and Futures Commission; in Singapore by Neuberger Berman Singapore Pte. Limited (Company No. 200821844K), which currently carries out the regulated activity of fund management under the Securities and Futures Act (Chapter 289) ("SFA") and operates as an Exempt Financial Adviser under section 23(1)(d) of the Financial Advisers Act (Chapter 110) ("FAA") of Singapore. Under the FAA, NB Singapore is exempted from Sections 25, 27 and 36 of the FAA, where its financial advisory service is provided to an accredited or expert investor (as defined in Section 4A of the SFA); in Taiwan to specific professional investors or financial institutions for internal use only by Neuberger Berman Taiwan Limited, which is licensed and regulated by the Financial Services Commission ("FSC") and a separate entity and independently operated business, with FSC operating license no.:(102) FSC SICE no.011, and address at: 10F, No. 1, Songzhi Road, Taipei, Telephone number: (02) 87268280; and in Japan and Korea by Neuberger Berman East Asia Limited, which is authorized and regulated by the Financial Services Agency of Japan and the Financial Services Commission of Republic of Korea, respectively (please visit http://www.nb.com/japan/risk_eng.html for additional disclosure items required under the Financial Instruments and Exchange Act of Japan). Except for the foregoing, this material is not intended for use or distribution within or aimed at the residents of any other country or jurisdiction. This document is not an advertisement and is not intended for public use or additional distribution in the following jurisdictions: Brunei, Thailand, Malaysia and China.
The "Neuberger Berman" name and logo are registered service marks of Neuberger Berman Group LLC.
© 2009-2015 Neuberger Berman LLC. | All rights reserved
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.