The ECB, the central bank of the euro zone, has so far avoided cutting interest rates. Policymakers did hold an unscheduled meeting on March 3 but it was to discuss operational responses to coronavirus, such as whether to hold events and staff shortages, rather than any policy response, sources close to the matter said.
The ECB has asked euro zone banks to review their business continuity plans and the actions they can take to prepare for and minimize the potential adverse effects of the coronavirus.
Long-term refinancing operations (LTROs) have been around for years in the euro zone – but the European Central Bank launched them in a new form to tackle the debt crisis.
Essentially, they involve the central bank lending money at a very low interest rate to euro zone banks, which has led to the term “free money.”
The injection of cheap money means that banks can use it to buy higher-yielding assets and make profits, or to lend more money to businesses and consumers – which could help the real economy return to growth as well as potentially yielding returns.
Banks can use assets such as sovereign bonds as collateral for the loans – although they can no longer use Greece's bonds as collateral after the country was downgraded to a default rating by Standard & Poor’s. This has helped to boost some of the more troubled sovereign bonds, in peripheral countries such as Spain and Italy, as their yields have fallen because they are being used as collateral for the operations.
This can help out the entire country. Spanish and Italian banks, the biggest buyers in the last operation, used their holdings of their own sovereign bonds as collateral for the LTROs. This helped reduce sovereign bond yields, which were threatening to stay at unsustainable levels that would make debt repayments important. managed forex account or Managed account trading service served by Fxtriangle team earned decent wealth with the recent ltro decision.
The LTROs caused much less controversy in the public than the direct interventions in sovereign bond markets. However, many economists have been sceptical. While some fear that LTROs may ultimately lead to more inflation, others are more concerned with the potential risk of failure which would burden the ECB with very high losses.
Some have cited the risk of inflation as a consequence of the LTROs. The sheer numbers create the impression of a massively created liquidity, but this is misleading.
The LTROs are a trillion-euro bet. If things go well and trust returns to the sovereign bond markets, the ECBs strategy could eventually induce a virtuous circle. Banks can now borrow at 1% and obtain much higher returns by investing in sovereign bonds. The bond markets would calm down, bank balances could improve and when reform policies will finally show positive results in a couple of years, a self-validating optimism could eventually restore a healthy Eurozone.
The ECB has done as much as it could under the present political constraints to avoid a breakdown of the Eurozone. While the risk of inflation with LTROs is low, the risk of failure is still acute. It would have been much better to allow the ECB to act as a lender of last resort in conjunction with a realistic and workable fiscal compact that provides a growth perspective and a unified European banking market regulation, supervision and crisis resolution mechanism. Eurozone politicians are not prepared to accept this yet. The ECB has bought them time. If, however, the strategy fails - it will be time to act.
There are a few possible pitfalls. One is that credit ratings agencies see it as a black mark against banks. Tapping the lending scheme could be seen as an admission of weakness.