ECB Continues Down Rate Reduction Road

The European Central Bank (ECB) stunned the market with three-pronged cut in interest rates and expansion of its bond-buying program.

The ECB trimmed the interest rate on the main refinancing operations of the eurosystem by 5 basis points down to 0.00 percent. The interest rate on the marginal lending facility has been cut by 5 basis points to 0.25 percent. In addition, the interest rate on the deposit facility will be decreased by 10 basis points to -0.40 percent. All changes are effective from March 16, 2016.

ECB president Mario Draghi said while very low or even negative inflation rates are unavoidable over the next few months due to movements in oil prices, it is crucial to avoid second-round effects by securing the return of inflation to levels below, but close to, 2 percent without undue delay.

The ECB also boosted the monthly purchases under the asset purchase program to €80 billion starting in April. The current rate is €60 billion. The quantitative easing (QE) program is expected to run until the end of March 2017, or beyond if necessary. Investment grade euro-denominated bonds issued by non-bank corporations established in the eurozone will be included in the list of assets that are eligible for regular purchases.

Related Link: Turnaround In Oil Gives Market A Boost Ahead Of Thursday ECB Meeting

New, Longer-Term Refinancing Operations

A new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years, will be launched in June 2016. Borrowing conditions in these operations could be as low as the interest rate on the deposit facility.

"This comprehensive package will exploit the synergies between the different instruments and has been calibrated to further ease financing conditions, stimulate new credit provision and thereby reinforce the momentum of the euro area's economic recovery and accelerate the return of inflation to levels below, but close to, 2 percent," Draghi said in a statement.

Responses

Several experts stated the recent announcement from ECB as "bold move" and the inclusion of corporate in the asset purchase program is being hailed as "huge."

"Markets had been expecting a cut of 10 basis points on the deposit facility so this decision won't come as a surprise," said Dean Turner, an economist at UBS Wealth Management told in Dow Jones Market Talk. "Indeed many banks will be relieved the cut isn't steeper. However, a reduction of 5 basis points in the main refinancing rate was not widely expected," he added.

The European Central Bank's move to add investment grade corporate bonds to the mix should allow it to provide liquidity "directly to the markets and around the banks," TD Securities told Dow Jones. Banks shouldn't be disappointed, though, as the four new TLTROs offered at the deposit rate, not the refinancing rate is a big benefit to banks and risk sentiment, TD Securities added.

"The market was expecting a lot from the ECB and the early evidence suggests that Mario Draghi delivered," Alan Gayle, director of asset allocation at RidgeWorth Investments, told Dow Jones. However, he warns the immediate euphoria in stocks may be short lived.

S&P 500 are currently up nearly 0.09 percent and Stoxx Europe 600 gained about 1 percent. Gayle said he's not adding to his position in European stocks just yet since he wants to see these policies driving growth in the eurozone, which should boost profits and stocks over the longer run.

"The concern that I have is that the marginal benefit from these extraordinary central bank moves has diminished. I'm not dancing in the streets here."

Meanwhile, eurozone real GDP growth was confirmed at 0.3 percent, quarter on quarter, in the fourth quarter of 2015, supported by domestic demand, while being dampened by a negative contribution from net exports.

Looking ahead, the ECB expects economic recovery to proceed at a moderate pace. On the basis of current futures prices for energy, inflation rates are expected to remain at negative levels in the coming months and to pick up later in 2016. Thereafter, supported by the monetary policy measures and the expected economic recovery, inflation rates should recover further.