ECB Lowers Rates: SAN, DB, CS in Focus
In a move that surprised financial markets, the ECB reduced rates and announced new stimulus measures. These moves are aimed at combating dismal inflation levels which threaten to further weaken Eurozone’s ailing economy. The announcement immediately impacted the Euro, which plunged, while stock and bond markets responded enthusiastically to these measures.
Rate Cuts and Asset Purchases
ECB reduced its major refinancing rate from 0.15% to 0.05%. The deposit facility rate was lowered to a negative 0.2% from a negative 0.1%. The decision to set a negative interest rate was taken in June. At that time itself, the ECB emerged as the largest central bank to set a negative rate on deposits.
The idea behind such a stance was to get banks to lend surplus funds to other financial entities. This is because a negative rate would mean paying the ECB to park excess funds.
Additionally, ECB announced it will start purchasing asset-backed securities and covered bonds issued by Eurozone banks. The central bank said further details will be released next month.
ECB President Mario Draghi did not outline the scale of such purchases. However, he said the ECB’s target was to enlarge its balance sheet to €2.7 trillion, its size at the start of 2012, from the current €2 trillion.
The 2011 covered bond purchase program had met with little success. However, the new policy of asset backed purchases signals the ECB’s strong resolve to ward off the threat of severe deflation.
Discouraging Inflation Data
Recent reports on inflation data possibly demanded such intervention. Germany posted higher-than-expected unemployment rate in August with a dismal inflation rate of 0.8%. On the other hand, Spain saw annual deflation rate of 0.5% in August.
Moreover, Belgium’s inflation rate reached 0.02%, the lowest level in about 5 years. Additionally, Eurozone’s inflation rate is expected to decline from 0.4% in July to almost 0.3% in August, much behind the ECB’s target of 2%.
Dismal Economic Growth
These inflation numbers have been accompanied by similarly discouraging growth numbers. Eurozone economic growth stalled in the second quarter. The zero growth reported by Eurostat was contrary to expectations of an increase of 0.1%. GDP had increased 0.2% in the Eurozone in the first quarter.
Germany's Federal Statistics Office reported a 0.2% contraction in the second quarter. Eurozone’s third-largest economy, Italy slipped into recession after its GDP shrank 0.2% in the second quarter. France, which along with Germany, contributes 66% of the bloc’s GDP, saw zero growth in the second quarter.
Following these numbers, France’s Finance Minister Michel Sapin urged ECB to be more active to offset deflation threats and to boost growth. Sapin said the region requires monetary policy “adapted to the exceptional situation of weak growth and weak inflation across the Eurozone.”
Impact and Criticism
Draghi seems to have responded to such suggestions quite effectively. However, he eliminated the possibility of more interest rate reductions. Draghi said: "Now we are at the lower bound." He also indicated that the new stimulus measures were not taken in one voice by the ECB. "Some were in favor of doing more, some were in favor of doing less," he added.
Jens Weidmann, president of Germany’s central bank was not in favor of such monetary easing. He is of the view that the effects of new bank loans, data on which is due later this month, should have been taken into account before implementing such measures.
After the rate-cut was declared, the euro dropped 1.6% against the dollar to $1.29, a 14-month low. Such a drop will raise the price of imports, which is expected to push up inflation.
Stocks in Focus
The initial impact of the ECB’s measures is expected to be felt by banking stocks. The ECB has decided to create a unified watchdog for all Eurozone banks before the end of the year. Ahead of its assumption of formal control on Nov 4 this year, the ECB is carrying out an exhaustive evaluation of the health of banks in the economic union. This includes 128 banks that hold 85% of all banking assets in the 18 countries which use a common currency.
Banco Santander, S.A. (SAN) is the biggest bank in Spain as well as Latin America. It also operates across four segments: Sovereign, Latin America, UK and Continental Europe. The Bank provides banking services for individuals and companies, leasing, factoring, stock brokerage and mutual fund services. Its European operations are conducted via Bank Zachodni WBK, Santander Totta and Santander Consumer Bank.
Deutsche Bank AG (DB) is the largest bank in Germany and one of the largest financial institutions in Europe and the world, as measured by total assets (1,637 billion as of Mar 31, 2014). As of that date, the company had 97,184 full-time employees and operated in 72 countries with 2,853 branches, of which about 66% were in Germany.
Credit Suisse Group AG (CS) offers investment products, private banking and financial advisory services, as well as insurance and pension solutions. The company conducts its operations through four divisions: Private banking, investment banking, asset management and shares services. These divisions provide securities underwriting, sales and trading, financial advisory, investment research, venture capital and asset management services, among others.
The Eurozone has a lot of catching up to do with other countries such as the U.S. and U.K in terms of affirmative action from central bank authorities. The ECB has initiated similar measures which stop short of government bond purchases. These are long awaited steps and may only be the beginning of additional steps to stimulate the region’s economy.
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