Thursday, September 4, 2014

4/9/2014: ECB: Little Done. Loads More to Be Done Still...

In its latest move in attempting to combat the risk of deflation in the euro area, the ECB pushed the policy interest rate down to 0.05% from 0.15%. Here are some historical dynamics of the rates and comparative analysis of the ECB policy relative to other Central Banks:

Let's start from the historical chart:

The chart is showing the historical evolution of the rates in six advanced economies. At this stage, we have a statistical convergence between the US, Japanese and Euro area rates at the lower margin feasible.

It is worth noting that from January 1999 through September 2008, pre-crisis average for the Euro rates is 3.10 which is now 3.05 percentage points above the current rate. In the case of the US, current rates are 3.37 percentage points below the pre-crisis average. In the UK, historical pre-crisis average is 4.83% which means we are at 4.33 percentage points below the historical average.

The dynamics of deviations in the ECB rates from their historical average are shown below:

Statistically, mean reversion in rates is now well-overdue and accounting for likely overshooting we are looking at the mean reversion taking the rates above 3.25-3.5%. Total duration of periods of deviation from the mean in the last episodes (for rates both above and below the mean) is 85 months over 9 years and 11 months. Current deviation is already 70 months long and counting. Excluding the 1999 period, which is consistent with the period of early establishment of the euro policy, total length of combined deviations from the historical average is 78 months, just 8 months short of the current period duration.

The higher the hill in the above chart gets, and the deeper the blue line goes, the greater pain will be required to revert the rates to their historical mean. This pain is coming, whether we like it or not and its timing and extent will have nothing to do with the legacy debts in Ireland or with our capacity to service them. It will come on foot of the Big 4 euro states data.

Meanwhile, this will do preciously nothing for the euro area economy. Why? Because the problem in the euro area economy is not the rates on loans to banks or between banks, as illustrated by the chart below. The problem is that policy rates are not feeding through to the retail rates charged on real loans for real companies and households in the real economy:

As the above chart clearly shows, the banking rates track reasonably well the policy rate (blue line, showing 12 months euribor rate deviation from the ECB repo rate), but the real rates (retail rates charged on loans in excess of EUR1 million with 1-5 years maturity for euro area non-financial companies) are getting increasingly more expensive compared to the ECB repo rates (red line).

The latest cut in rates is not going to do anything to the above story. And the ECB, so far, has found no means for breaking the financial markets blockage that prevents the policy rate to feed through to the retail rates. Nor, incidentally, has the ECB discovered any means so far to break the cycle of fragmentation in the credit system - the situation where by credit rates for non-financial companies and households diverge between different countries of the euro area.

Two real and actual problems: not cured. One imaginary problem - of official policy not being absurdly accommodative enough - is now addressed. Little done. Loads to be done still... and the future interest rates hikes super gun is loaded, primed and the fuse lit already...
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