Post-Crisis ECB Considers How It'll Set Rates in the Future

Link: Post-Crisis ECB Considers How It'll Set Rates in the Future

Date: 24th October, 2018

Media: Bloomberg 

What happened?

After pumping cash into the markets for over than a decade, the European Central Bank (ECB) is considering the way it controls interest rates and transmits monetary policy. The ECB will have to determine its monetary policy framework to adapt it to a new era characterized by the contraction of the stimulus measures and the reduction of its balance sheet and excessive liquidity.

Whom and where it affects? 

It mainly affects the ECB and the national central banks of all countries that have adopted the euro.

What sort of public or private institutions are involved?

Among public institutions involved, we can find the European Central Bank (ECB), the Federal Reserve (FED) and the Bank of England (BOE). 

Why is it important for Banking and Finance? 

Changing the monetary policy framework of the Eurosystem could affect the entire banking and financial system. The main objective of the ECB is to maintain price stability in the euro zone; through interest rates, it can influence economic activity, alining it with inflation objectives. 

Focusing on the banking sector and taking into account that one of its main functions is to transmit monetary policy, a change in its framework would mean a turn on its business strategies.

What do you think will be the consequences in the foreseeable future?

Since the main objective of the Eurosystem is to ensure price stability and taking into account that the HCIP (Harmonised Index of Consumer Prices) is around 2.1% for the euro area, what we can expect is the implementation of monetary policies that prevent higher inflation. This will inevitably lead to the reduction of the quantitative easing programmes and the rise of interest rates on Main Refinancing Operations (MRO), Deposit facility, and Marginal Lending Facility.

The increase in interest rates will make borrowing more expensive and saving more attractive. This will have important effects throughout the entire financial system and affect growth development. Some of the plausible consequences of this decision could be: the increase of interbank lending rates (Eonia and Euribor) and the subsequent effect on assets that depend on these indexes; more expensive bank loans and credits and more attractive deposits, a situation that might improve banks' income statements; increasing yield expectations over bonds, rising financing costs both for governments and corporations, and putting pressure on stock markets, demanding higher returns.

Summing up, a change in the monetary policy framework would inevitably lead to a scenario of costly financing, investment decline and more savings that would cause a deceleration of economic growth. Nevertheless, it is important to emphasize the complexity of this decision, that would be made after careful deliberations and in the right time. 

Key words:

Monetary Policy, ECB, Deposit Facility, Eonia and Euribor.