Draghi fires bazooka, but we are still waiting for the cavalry

The European Central Bank (ECB) cut interest rates across the board with the deposit rate dropping another 10 basis points (bps) to -0.4%, while the main refinancing rate has been reduced by 5 bps to 0%. The quantitative easing (QE) programme has been stepped up by €20 billion to €80 billion per month, starting from April and will include non-bank investment grade euro corporate bonds. Finally, the ECB announced a new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years, starting in June 2016. Borrowing conditions in these operations can be as low as the interest rate on the deposit facility if a bank exceeds its lending benchmark.

These moves can be seen in the context of another downgrade to the ECB’s inflation forecast to 0.1% this year (previously 1%) and 1.3% next year (previously 1.6%). Growth forecasts were also trimmed.

However, while today’s action may have exceeded expectations, the ECB President then disappointed markets with his comment in the press conference that the governing council was not looking to cut rates further. This reversed the rally in equities and led to a sharp rebound in the euro to 1.12 versus the US dollar, after an initial drop to 1.08. Government bond yields followed a similar path and as a result financial market conditions will have tightened on the day.

The hope will be that by increasing the incentive for banks to lend we will see a revival in investment and growth. However, alongside doubts about the efficacy of negative interest rates, the weakness of capital spending is global and reflects a reluctance to borrow as much as an unwillingness to lend. As Draghi has indicated, he needs the support of governments and fiscal policy to win this fight.