Rapid Rate Cuts and Extreme Easing

Executive Summary

• The past week has seen an avalanche of global monetary policy easing, including from the European Central Bank and Bank of England, with most central banks also signaling they are prepared to ease further as needed.
• Even these aggressive monetary policy actions, however, may not be enough to prevent economies from falling into recession. For example, we expect the Eurozone and United Kingdom will suffer extended periods of contraction during 2020. We also believe it will be difficult for the European Central Bank and the Bank of England to remain on the sidelines while their respective economies contract for an extended period.
• As a result, even after this month’s actions, we still expect the European Central Bank and Bank of England will ease further. Specifically for the ECB, we expect an extra €120B of purchases starting in late Q3/early Q4 spread over a year, or a purchase pace of €10B/month. For the BoE, we expect a new round of asset purchases of perhaps £125B-£150B, again beginning by late Q3/early Q4.

European Central Bank Eases

The European Central Bank, at a widely anticipated announcement, eased monetary policy last week. Although the central bank did not lower its benchmark interest rates (specifically its deposit rate which remains at -0.50%), it did introduce a range of other important measures:

• An additional temporary Long Term Refinancing Operation (LTRO) to provide liquidity and bridge the period until the third targeted lending operation (TLTRO III) in June 2020.
• More favorable terms and conditions for the TLTRO operations which run from June 2020 to June 2021. The interest rate for TLTRO funding will be 25 bps below the average main refinancing rate over the life of the loan. For banks which meet lending targets (and that target has been lowered to 0%—banks simply need to maintain currently lending levels), the interest rate will be 25 bps below the average deposit rate.
• The ECB has increased the amount that banks can potentially borrow thru the TLTRO III program.
• Additional net asset purchases of €120B through until the end of 2020.

While there was perhaps disappointment at the lack of an interest rate cut, it was still a comprehensive range of measures. Nonetheless, we still expect the Eurozone economy to fall into recession, a recession which could last several quarters. Against this backdrop, we believe it may be difficult for the ECB to remain on the sidelines while the economy contracts for an extended period, and thus we expect the ECB will ease monetary policy again later this year.

The timing and form of additional ECB easing remains uncertain. That said, we see late Q3 for a likely timing for further policy action, as we expect the ECB will want to monitor the impact of its initial TLTRO III operations before taking further action. Moreover, while the more favorable TLTRO III terms likely offer some increased scope for further rate cuts, we lean towards further easing taking the form of another increase in asset purchases, aimed at lowering yields and improving monetary policy transmission. A combination of economic contraction and fiscal stimulus should lead to increased European government bond issuance which, combined with some adjustment to issuer limit, could provide the ECB with enough room to add to its purchases. We envisage perhaps an extra €120B of purchases starting in late Q3/early Q4 spread over a year, or a purchase pace of €10B/month.

U.K. Central Bank Cuts

The Bank of England (BoE) also eased monetary policy last week through a range of action. Most importantly, the BoE cut its Bank Rate 50 bps to 0.25%. We think that likely represents the end of the central bank’s rate cut cycle. Overnight interbank rates have tended to trade just below the BoE’s target for the Bank Rate, so if the BoE were to cut rates to zero interbank rates could turn negative, something the central bank may wish to avoid.

In addition to the rate cut, the BoE announced a new Term Funding Scheme with incentives for small- and medium-sized enterprises (TFSME). This is a program that offers low cost, long-term funding to banks and incentivizes those banks to lend to the real economy, particularly small- and medium-sized businesses. Specifically, it offers banks four-year loans at or close to the Bank Rate (0.25% at present), with the exact cost and borrowing limits dependent on the extent to which banks provide loans to the real economy—the more that banks lend, the more they can borrow and the lower their borrowing rate will be through the TSFME. This program is akin to the European Central Bank’s Targeted Long-Term Refinancing Operations (TLTROs), and should support U.K. banks and the businesses they lend to as they navigate the next few months of economic challenges. U.K. bank supervisors also announced they would reduce the countercyclical capital buffer (CCB) rate to 0% from 1% for the nation’s banks.

Still, as with the Eurozone we do not believe these measures will be enough for the U.K. economy to avoid recession, and both outgoing central bank governor Carney and incoming central bank governor Bailey have signaled they are prepared to ease policy further, if needed. Accordingly we expect the Bank of England will resume its asset purchase program in either Q3 or Q4. The Bank of England purchased £200B pounds of assets during its first round of quantitative easing and £175B during its second round of quantitative easing, with additional purchases also taking place in 2016 following the Brexit referendum. We expect a new round of asset purchases could be slightly less, perhaps £125B-£150B, again beginning by late Q3 of early Q4.

Rate Cuts, Rate Cuts Everywhere

The European Central Bank and Bank of England are far from the only central banks to ease monetary policy since just last week. In addition to the Federal Reserve’s unscheduled monetary policy easing this past weekend, other central bank activity has included.

• Norway: An unscheduled 50 bps policy rate cut to 1.00%, and a signal that is prepared to cut rates further. The countercyclical buffer required by banks was also reduced.
• Canada: An unscheduled 50 bps policy rate cut to 0.75% and a pledge to adjust monetary policy further, if required.
• New Zealand: An unscheduled 75 bps policy rate cut to 0.25%, with rates to remain at that level for at least 12 months. The central bank also said it would ease further if needed, most likely through large scale purchases of New Zealand government bonds.
• Japan: At an emergency meeting, the Bank of Japan adjusted its policy stance by doubling its purchase target for exchange traded funds to ¥12 trillion, as well as introducing a new lending program to help businesses hit by COVID-19.
• South Korea: An unscheduled 50 bps policy rate cut to 0.75% from the Bank of Korea, along with a signal that it is ready to respond with all available tools if needed.
• Czech Republic: An unscheduled 50 bps policy rate cut to 1.75%, with a bias to ease further.
• Chile: An unscheduled 75 bps policy rate cut to 1.00%, as well as additional credit lines to banks.
• Turkey: An unscheduled 100 bps policy rate cut to 9.75%, along with a series of measures to boost liquidity.
• Poland: An emergency 50 bps policy rate cut to 1.00% as well as a reduction to banks’ reserve requirements.