European Central Bank has aggressive plan
By Laif Meidell, CMT, president of American Wealth Management, and portfolio manager of the AdvisorShares Meidell Tactical Advantage ETF (MATH)
Mario Draghi, the president of the European Central Bank, was at the center of the global financial stage Thursday, as the world waited to hear what steps the ECB would be taking, if any, to improve the European economy. President Draghi, the man who promised to do “whatever it takes” to preserve the euro, didn’t disappoint as he laid out his aggressive plan to protect the region’s fragile economy.
The ECB’s big concern at the moment is persistently weak inflation, which was reported earlier in the week to be at 0.5 percent for the month of May. If left unchecked, the low inflationary environment could turn into deflation, a self-feeding spiral that can depress consumer prices, wages and job creation and can be extremely difficult to reinflate.
As part of the plan, the ECB cut interest rates on up to 400 billion euros ($545 billion) in cheap loans available to banks as long as they lend more to small businesses. The length of loans would be for four years, which is longer than many had expected, and underscores the ECB’s current concerns.
The ECB also cut its main lending rate from 0.25 percent to 0.15 percent, meaning that banks from Spain and in other regions of the eurozone can borrow more cheaply from the central bank. In a bold move, while sending a message, the ECB cut the rate on bank deposits parked overnight with the central bank to minus-0.1 percent. In other words, the central bank will be charging commercial banks to keep their money at the ECB.
Finally, President Draghi promised to do more if necessary and indicated he would be considering a plan that included buying asset-backed securities and bundles of bank loans. Such a move would be similar to the Federal Reserve’s existing quantitative easing plan.
Although bonds have generally been in a downtrend over the past week, they ended higher on Thursday following President Draghi’s lower interest rate plan. Although low interest rates are good for businesses, they can be problematic for the saver, who may feel forced to take on more risk in order to make up for the lost interest.
This commentary originally published in the Reno Gazette-Journal. Performance numbers used in this article were obtained through eSignal and are not guaranteed to be accurate.