March 12, 2020 / 3:35 PM / in 22 days

Breakingviews - ECB’s stealth easing enlists banks in virus fight

European Central Bank (ECB) President Christine Lagarde gestures as she addresses a news conference on the outcome of the meeting of the Governing Council, in Frankfurt, Germany, March 12, 2020.

LONDON (Reuters Breakingviews) - Christine Lagarde is hoping the banking sector will be her new best friend. Less than four months after taking office, the European Central Bank boss has taken a stealth approach to monetary easing that relies on lenders to help combat the damage the coronavirus risks wreaking on the euro zone economy.

Lagarde left the ECB’s key policy interest rate unchanged at minus 0.5% on Thursday. This came as a shock to many investors who had expected she would announce at least a token reduction, even if she lacked the ability to match the emergency half-percentage point cuts announced by the Federal Reserve and Bank of England earlier this month. As markets tumbled on both sides of the Atlantic, however, she produced a more cunning plan to help the euro zone, whose fragile growth prospects have been whacked by a virus that has locked down Italy, cancelled travel and closed schools elsewhere.

Instead of cutting the deposit rate even deeper into negative territory – which would squeeze bank earnings – Lagarde is tempting lenders with better-than-free money. They will be able to tap an existing longer-term lending facility at rates as low as minus 0.75%. That’s below the rate for deposits parked at the central bank. The ECB simultaneously increased the maximum banks will be able to borrow in this way to half the eligible loans on their balance sheets. The ECB’s bank supervision arm also chipped in, giving lenders a temporary pass to dip into capital and cash buffers. These measures give banks little excuse not to lend, provided households and businesses want to borrow, and reduce the risk of a sharp but temporary slowdown turning into credit crunch.

Lagarde also gave herself more leeway – 120 billion euros’ worth – to ramp up the ECB’s bond buying. However, she may yet be haunted by a throwaway line at her press conference that the ECB was not there to close the gap between yields on the safest euro zone government bonds and those issued by other countries.

Yields on Italian and other southern European government debt have been rising even as those on benchmark German bonds have been falling, reflecting worries that the coronavirus will reopen cracks in the euro zone economy. They moved further in opposite directions after her remarks, with Italian 10-year government bond yields on track for their biggest one-day increase since the height of the euro zone crisis in 2011.

Fears of losses on their government bond portfolios will make banks less able – or inclined – to do what Lagarde wants. Best friends aren’t made overnight.

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