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 Five people familiar with the measures being prepared detailed plans
involving a potential rate cut, including the ECB's deposit rate
going negative for the first time, along with the targeted measures
SME measures.
The package offers some stimulus for the euro zone economy but falls
short of the large-scale effect the ECB could unleash with a major
program of quantitative easing (QE) - money printing to buy assets.
Such a QE plan is still some way off.
A June rate cut is "more or less a done deal", said one of the five
sources who spoke to Reuters on condition of anonymity.
A second source echoed that sentiment, and added: "This will be the
first major central bank to move to a negative deposit rate. That
would move the exchange rate."
ECB Executive Board member Peter Praet also told German weekly
newspaper Die Zeit the central bank could cut its deposit rate into
negative territory as part of a package of policy measures that
could also include a targeted long-term refinancing operation (LTRO).
The latter is a method of boosting bank liquidity in the euro zone
with an eye to increasing lending.
The first two sources spoke to Reuters of a cut of 10-20 basis
points, probably in all three ECB rates. The main refinancing rate
is currently at 0.25 percent.
Both sources expected the move to bring down the currency exchange
rate but said the ECB had made no calculation of how much it was
likely to fall by, and had no target for the euro.
The ECB declined to comment when asked about the plans.
ECB President Mario Draghi said last week the Governing Council was
"comfortable with acting next time" - its June 5 policy meeting -
but wanted to see updated economic projections from the bank's staff
first.
"Negative deposit rates are a possible part of a combination of
measures," Praet told Die Zeit. "We are preparing a range of things.
We could again lend banks money for a longer time frame, possibly
with conditions attached."
Praet did not see the ECB embarking on U.S.-style QE unless economic
conditions deteriorated: "I think it will only come to that if the
euro zone economy and inflation develop significantly worse than we
expect," he said.
DANGER ZONE
The ECB's deposit rate already stands at zero and a cut into
negative territory would see it essentially charge banks for holding
their money overnight - a move that could spur more lending, though
analysts are unsure how banks would react.
The ECB is concerned by the euro's strength and low inflation, which
Draghi is worried could get stuck in what he calls a "danger zone"
below 1 percent. At 0.7 percent, inflation is running well below the
ECB's target of just under 2 percent.
The bank is also concerned about weak lending to SMEs.
Another source was less sure the new staff forecasts would merit
policy action but confirmed a package was under discussion should
the Council decide to act. Some analysts believe a small cut in the
ECB's interest rates would have little impact.
In February, ECB Executive Board member Benoit Coeure told Reuters
the idea of cutting the deposit rate into negative territory was "a
very possible option", before adding: "But you should not expect too
much of it.
BOOSTING LENDING
Should it decide to cut rates, the ECB is looking at also deploying
either a targeted long-term loan operation, or LTRO, or else
announcing a purchasing program to buy asset-backed securities (ABS)
comprised of bundled SME loans.
The targeted LTRO, which ECB staff have been working on for weeks,
would come with conditions attached on achieving a measurable
increase of banks' lending to SMEs.
The operation could be even longer than 3-year LTROs the ECB
deployed in late 2011 and early 2012 to head off a funding crunch.
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"Three years has to be the minimum if we want to have an impact on
boosting lending to small business," one of the sources said. "It
may be for longer as well."
As an alternative to the targeted LTRO, the ABS purchase plan would
see the ECB buy bundled packages of SME loans. This could be
announced in June with a view to coming into operation late this
year, two sources said.
The idea behind this second option is to build the market in Europe
for SME loans bundled as ABS, with a view to making it larger and
more liquid to aid the flow of credit to the smaller firms that form
the backbone of the euro zone economy.
While developing this purchase plan, the ECB is also lobbying
banking regulators in Basel to loosen the capital requirements on
banks holding high-grade ABS.
One of the five sources said the ABS purchase idea was on the table
but, because it would take time to make it operational, the measure
might not be announced in June.
Another said the ABS purchase plan for securitized SME loans was
premature and not ripe for decision or announcement in June, adding:
"What you should expect is an LTRO that could be even more than 3
years at a fixed rate."
That would lend teeth to the ECB's forward guidance on rates. Asked
how conditionality of banks increasing lending to SMEs could be
enforced, he said that there could be for example a 4-year LTRO at a
fixed rate of 25 basis points with an interest rate penalty if a
bank did not meet the conditions.
NO QE
The tools being prepared are consistent with measures Draghi
identified in an April 24 speech in which he explained how the ECB
would respond to three broad scenarios.
To respond to a de facto tightening of monetary policy caused by
market moves like further euro gains, Draghi indicated the ECB could
cut rates.
To deal with problems transmitting its policy to all parts of the
euro zone, he said the bank could deploy an LTRO targeted at
encouraging bank lending or an ABS purchase program.
Under a third scenario of a deterioration in the medium-term
inflation outlook, Draghi said on April 24 the ECB could respond
with a "broad-based asset purchase program" - potentially QE.
However, just a few days later - at a meeting with German lawmakers
- Draghi played down the prospect of QE any time soon.
"He mentioned quantitative easing in this context but made clear
that we're still some way off QE," a source who attended the meeting
with German lawmakers said.
One of the sources who spoke to Reuters for this story also said QE
was some way off but another said he could imagine further measures
potentially being examined later this year.
"It's not QE yet," the source said of the package being prepared for
June. "This is now, and autumn is later. You could think about some
more things then if it is well prepared."
(Writing by Paul Carrel Editing by Jeremy Gaunt)
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