Draghi pulls a risky rabbit out of his hat

March 10, 2016

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Mario Draghi has rediscovered his mojo. The European Central Bank chief may have underwhelmed investors in December but bounced back on Thursday by unveiling an aggressive package of easing measures that triggered a big market rally. The problem: he may be encouraging excessive risk-taking without being able to lift inflation.

Stock and bond prices shot up while credit indices tightened sharply after Draghi increased the value of monthly ECB asset purchases by a third to 80 billion euros, and said non-bank investment-grade corporate bonds would qualify for its buying programme, which aims to spur economic activity by cutting borrowing costs. He also unveiled plans for new four-year loans for banks. These could carry interest rates as low as the deposit rate, which was cut by 10 basis points to minus 0.4 percent.

The ECB’s plan to buy corporate bonds is a radical departure for a central bank that was far more conservative than its peers during the financial crisis. But there are also several sleights of hand.

First, while bonds issued by banks still don’t qualify for ECB buying, Draghi is helping them by indirectly cutting their funding costs. As yields on other corporate debt fall due to ECB buying, investors will turn to bank debt and subordinated bonds. Second, negative rates for long-term loans would mean the ECB effectively pays banks to borrow. This would mitigate any damage done to bank margins by the more negative deposit rate. No wonder the EURO STOXX Banks index rose 4.9 percent, outperforming the wider market, and the iTraxx Senior Financials index tightened 10 basis points to 87 basis points.

But all this light and joy can’t distract from a couple of rather big clouds. Given euro zone inflation has failed to respond much to past easing, it’s unclear whether Draghi’s new measures can spur consumer prices this time. Worse, the ECB chief just gave investors a new reason to disregard fundamentals when buying corporate bonds. When the ECB’s easing party finally ends, the excessive risk-taking it is encouraging could leave an even bigger hangover.

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