The ECB Gets Its “Bazooka” Out

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What's going on?

On Thursday, the European Central Bank (ECB) announced measures aimed at boosting the European economy. Those measures were much more aggressive than expected – they were likened to a “bazooka” – but markets reacted poorly anyway.

What does this mean?

Banks, like Deutsche Bank, will get charged even more for depositing money with the ECB – that, in theory, encourages banks to lend money out to people and businesses because they don’t want to pay charges to the ECB. Also, banks will be, essentially, given money for them to lend on to businesses. Additionally, the ECB will directly buy companies’ debt (a.k.a. corporate bonds). That should lower the cost of such companies borrowing money because as the prices of their bonds rise (as the ECB buys them), their yields decline (click here for full explanation), thereby making it cheaper for them to issue more bonds in the future (i.e. take on more debt). All in all, the measures are designed to boost the amount of money available to people and businesses so that they go out and spend it on things like hiring workers, building factories and, generally, boosting production.

Why should I care?

For markets: In theory, the measures are good for European stocks but bad for the Euro – but the actual impact was the opposite. Initially stocks jumped and the Euro sold off. But, during the press conference that followed the meeting, ECB President Mario Draghi suggested that interest rates wouldn’t go any lower (sort of… what he said is open to interpretation). Some took that as a tacit admission that the ECB was running out of ammunition to further boost stocks and weaken the Euro. As a result, the Euro strengthened sharply and stocks ended the day 2.5% lower.

The bigger picture: Cash is available – will companies borrow it? This is about as close as it gets to “free” money for businesses: interest rates are extremely low. But, do companies want the money, even when it’s this cheap? They might be too wary of the weak economy to borrow and invest in building something new (ultimately, they will have to repay the money they borrow). There can be a lot of supply, but without the demand for the money, it’s not much use. And that’s why investors are increasingly concerned that actions such as Thursday’s are losing their efficacy.

Originally posted as part of the Finimize daily email.

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