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After the Fed elected to stand pat for the moment, the market is has switched its focus to Mario Draghi.His situation is someone different from Ben Bernanke’s, as the European Central Bank has a narrower mandate and more complicated system of government to deal with.
Morgan Stanley has put together a list of Draghi’s possible courses of action, we’ve separated them out by their rating of potential impact.
- Changing collateral requirements: The ECB could enact this on their own, however the impact would be muted outside of the markets that are directly affected.
- Buying EFSF (European Financial Stability Fund) debt: Not very effective as EFSF rates are already low, and it does not help lower periphery yields.
Low to medium impact:
- Extending LTRO (Long Term Refinancing Operations): This would involve extending the ECB’s program offering cheap long term loans to banks. Limited impact/take up as there is little appetite for risk or balance sheet expansion among European banks.
- Refinancing rate cut: Could be enacted by the ECB’s governing council alone, would result in cheaper funding for banks.
- Depository rate cut: This would involve making banks pay to hold reserves with the Central Bank. Morgan Stanley believes it would likely richen collateral rates, but not increase cross border interbank lending.
- Private debt purchases: Unlikely to occur as private bond purchases won’t affect the sovereign debt crisis.
- Revising seniority of Government bond holdings: This would take a bit more doing as it would require the assent of Euro area governments. Could have a very large impact, especially if the decision is retroactive. This would be the path towards a revised Greek bailout in which public debt holders take a haircut in the value of their bonds.
- Combining the SMP (Securities Market Program) with the EFSF (European Financial Stability Fund): There are significant barriers to such a program, a country would have to apply for a support program, the ECB and EC must agree that financial stability is under threat, finance ministers would have to accept the program, then the Euro area parliaments would vote. However, a coordinated program of bond purchases in the primary market (EFSF) and the secondary market (by the ECB) would be a powerful way to reduce periphery bond yields.
- ESM Banking licence: The ECB would serve as a counterparty for the ESM to buy up debt. The issue is that the EU treaty explicitly bans the monetary financing of EU institutions. The issue is currently being decided in German constitutional court. This would have a large impact as it would create a lender of last resort for governments.
- Quantitative easing: Purchases of public and private assets on a large scale. The ECB would have to justify this as a move to prevent downside risk to price stability, which Draghi started to do last week. Points to the ECB starting to serve as a lender of last resort for governments.
- Securities Market Program Alone: This would involve sterilized government bond purchases by the ECB. Since it is of fixed duration and has not been successful in limiting bond spreads and yields in the past, it is unlikely to be hugely effective.
- Funding for lending: This would copy a Bank of England program in which a bank could swap a loan to a household or business for a liquid asset from the central bank, paying an interest rate that is dependent on the bank’s level of lending. Could help increase loans to small businesses in the Eurozone.