Financial News

  • 6 June 2014, 10:17

Markets Want Kitchen Sink Thrown At Growth

The origin of the phrase "everything but the kitchen sink" goes back to WWII: households were encouraged to donate every metallic object in their homes - save for the porcelain in their kitchens.

As D-Day commemorations began, Mario Draghi, President of the European Central Bank, has thrown everything but the kitchen sink at the eurozone economy, which is threatened by deflation.

Although the acute stage of the euro's crisis is now more or less over, all the continent's chronic issues have come back to haunt it: dismal demographics, weak productivity, sclerotic regulatory systems. You can add to that list the miserable recovery from the crisis, record unemployment and, of course, the anti-EU vote in the European elections.

Draghi's plan consists, broadly speaking, of four parts:

1. Interest rates cut - the main refinancing rate from 0.25% to 0.15% and the deposit rate from zero to -0.1%. That makes the ECB the first major central bank to experiment with negative interest rates.

2. There will be a new ?400bn so-called Targeted Longer-Term Refinancing Operation (TLTRO) - a scheme whereby banks will be able to borrow long term (four-year) cheap cash from the ECB provided they lend out money to businesses.

3. The ECB will carry out "preparatory work on outright asset purchases" - aka the kind of quantitative easing seen in the UK and US.

4. It will stop issuing bonds to offset the ones it bought through its emergency Securities Markets Programme.

These steps are significant: Draghi has finally come good, to an extent.

The negative interest rate had been broadly expected; the TLTROs were a bit of a surprise (though the hope was that there would be more).

Together, they amount to a carrot-and-stick approach, the objective being to encourage banks to lend cash out. The carrot is the cheap funding banks will get if they lend to businesses; the stick, the fact they will be penalised for leaving cash on deposit with the ECB.

The problem is that neither tool is exactly well-tested. A few central banks have experimented with negative interest rates - among them the Danes and the Swedes. Neither case has been a massive success.

The Bank of England is very proud of its Funding for Lending scheme but it has enough detractors that one should hardly be overly optimistic about TLTRO's chances either.

Most tellingly, investors - who greeted the initial set of announcements with sheer unadulterated joy - later moderated their feelings.

The euro, which fell sharply upon news of the negative interest rate, later bounced back to close to where it started once Draghi had laid out the full details in his press conference.

It will take many months of data before we know whether the strategy is a success.

However, it's difficult to get escape the conclusion that the one thing markets didn't get today - outright eurozone quantitative easing - was the one thing they really wanted.

Having thrown everything but the kitchen sink at investors today, it looks like the kitchen sink was precisely what they were after.

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