The relatively calm demeanor of European Central Bank (ECB) President Mario Draghi belied the chaos in the markets Thursday morning, as the ECB cut its main refinancing rate to 0.05% from 0.15%. The bank also cut its deposit rate into greater negative territory, to -0.20% from -0.10%. Banks wanting the privilege of parking their money at the ECB will now have to pay more to do so.  It’s a loud and clear directive that member banks need to place their investable funds with European businesses and not the ECB.

Even more important, the ECB finally announced its plan to engage in quantitative easing – the last of the major central banks to do so.   While this move into QE was widely expected – unlike the rate cuts – the timing of the announcement was a surprise. The size of the ECB’s purchases is still unknown. 

The key element of the announcement was that the ECB will begin buying asset-backed securities – capital market instruments comprised of private-sector debt and derivatives.  This is significant in two ways:

1)In purchasing private instruments, the ECB is looking to grease the wheels of credit availability and lower interest rates to encourage more borrowing by European businesses.

2)By avoiding the purchase of government debt, the ECB is distancing itself from the appearance of financing government deficits.  Such a move would be illegal for the ECB to do, and fiercely resisted by Germany and other like-minded countries. Plus, there are indirect ways of accomplishing the same thing.

It’s clear that the package of measures was not supported by the core European countries – particularly Germany.  The decision to buy asset-backed securities was the one relative bright spot for the core countries.  Outside of that factor, the decision was essentially a blow to the strict economic policy camp.

My View: Europe’s economic and policy problems remain the same. This decision does not solve the underlying issue of coordinating fiscal and economic structural policies. However, it’s a bold move by Mr. Draghi, underscoring his growing reputation for gutsy policy moves and willingness to anger significant constituencies within the ECB to achieve his goals.

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