The trouble with currencies and monetary easing

Yesterday saw something which has happened at least twice now in 2016 and happened in December 2015 too. This is where economics 101 predicts that monetary easing will lead to a currency decline but in fact we see that the announcement effect of such a move is for it to rise. If we stick to the actions of the European Central Bank under its President Mario Draghi we saw some quite considerable easing yesterday including interest-rate cuts, more QE and a further subsidy to the banking sector hidden under the acronym LTTRO ( Long Term Targeted Refinancing Operations). Oh and in an addition for my financial lexicon for these times targeted means targeted at the banks!

However the result expected by economics 101 lasted for perhaps 60 minutes. Those on Twitter had barely enough time to tweet pictures of a Euro fall from just under 1.10 versus the US Dollar to 1.085 when it began to rise and rise and rise. The ECB nipped in quickly to set a reference rate of 1.0857 but reality as I type this is 1.111. Ouch! Now I would like to take us a little deeper into the rabbit hole as we have had approximately a year of this phase of QE and easing and according to the Bank Underground blog it amounts to this.

We know that asset purchases announced between April 2014 and March 2015 (QE1) totalled €1157bn.

Yet the ECB trade weighted exchange rate has risen from 89.43 to 92.86 over the past year and this is before we get to yesterday’s rise which it has not measured yet. As Jeff Lynne and the Electric Light Orchestra put it.

You took me, higher and higher
It’s a livin’ thing,
It’s a terrible thing to lose

What did Mario announce?

As predicted on here all of the main interest-rates were cut as shown below and I include the second one to point out that technically the economics concept of free money does now exist at the ECB.

The interest rate on the deposit facility will be decreased by 10 basis points to -0.40%, with effect from 16 March 2016……The interest rate on the main refinancing operations of the Eurosystem will be decreased by 5 basis points to 0.00%,

Regular readers will be aware that I was expecting something for the Italian banks which Mario used to supervise and our acronym returns with the emphasis being mine.

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

This matters as you see potentially banks can be paid to borrow from the ECB by the ECB! Here is the description of it.

Banks will pay the MRO rate at the time of bidding, so right now it’s zero. And they may even get a reduction on that rate which increases with the amount of loans they grant. So the maximum reduction will bring the rate on the TLTRO II to the level of the deposit facility rate at the time of bidding.

I note this on two grounds. Firstly the Bank of England used a similar system with its FLS which pumped up the UK mortgage market rather than the promised small business lending. Secondly when it was tried in Japan banks there made loans to qualify for aid that were constructed for that purpose. Financial vehicles were constructed to qualify so firms like Nissan,Toyota Sony got small business loans. Readers may recall I pointed out this on Monday from Bank Pictet.

Cost of negative rates = €2bn

Well the part for the banks seems set to be refunded but not for the rest of us such as savers. Anyway you don’t have to take my word for it that this is a bank subsidy.

The Italian banks are up by 7.25% as I type this.

Also as I pointed out on Share Radio there was a time when 20 billion Euros a month seemed a lot of money.

Second, we decided to expand the monthly purchases under our asset purchase programme from €60 billion at present to €80 billion.

Also Mario tried to calm fears that he might run out of bonds to buy by adding this into the mix.

we decided to include investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area in the list of assets that are eligible for regular purchases under a new corporate sector purchase programme.

Will some companies now be paid to borrow? We will have to wait and see.

Central banks are watching this

The Underground blog I referred to earlier noted this on  January 2015’s announcement by the ECB.

That means the effect of QE2 on asset prices was still notable, for example, we estimate the extension led to a 5% depreciation of the euro against the dollar and a 6% increase in equity prices.

Since then the Euro has slightly strengthened so we see that a past theme of here is correct that running into a new QE effort we do see currency falls but now we suspect that additions at best maintain the status quo or as Huey Lewis and the News put it.

I want a new drug – one that won’t hurt my head,
One that won’t make my mouth too dry, or make my eyes too red.

This returns us to the Junkie culture theme where ever-increasing doses of the narcotic are required to get us high which then morphs into more just to stand still and then possibly worse. Also I note that the Underground blog in a rather subversive manner confirms this.

Nevertheless, the extension’s impact was still substantially less than the initial programme both because the extension was smaller and had less impact per €100bn of purchases.

This caught my eye because Martin Weale of the Bank of England told us exactly the reverse earlier this week.

Furthermore, it seems to me that the second and third rounds of asset purchases were as effective as the first round.

Jingoism or us being better than Johnny Foreigner and if so why Martin? Time for Santana.

Jingo Ba

Bank of Japan

Governor Kuroda is lost in his own world of confusion where cutting interest-rates into negative territory has led to a stronger currency as well. The Banzai of the Japanese Yen dropping to 121.7 versus the US Dollar is more of a kamikaze now as it is at a much stronger 113.7.


There is much to consider here and let me add another reason for currencies to fall with monetary easing. It is that the “carry trade” where you borrow in the cheapest currency should push things lower as it is equivalent to selling a currency. Where does it all go wrong? Well a factor may be in these words from Mario Draghi.

we don’t anticipate that it will be necessary to reduce rates further…….To the extent that we have other instruments to do this, we’ll certainly shift the emphasis to other instruments.

It seems that markets believe this in the same way that they seem to have believed Governor Kuroda in Japan. This itself is awkward as Mario has given us higher estimates of the lower bound for interest-rates before and then cut to -0.4% so a selective memory is required. It is even worse for Governor Kuroda who introduced them only 8 days or on the Beatles definition a week after denying any such intention. Perhaps most subversive of all would be some mechanism where negative interest-rates strengthen currencies as the Swiss National Bank would blow up.

The truth may well be that so many places are trying to reduce their currencies at once that it is like a Tower of Babel which requires a mythical Babel Fish for us to make sense of it all!

Meanwhile let me give another nod to the excellent Yes Minister of 3 decades ago. Last night I saw an episode where the Minister’s daughter was planning to make a nude protest over badger culling. This morning I turned on the radio and the subject was contentious badger culling……..








18 thoughts on “The trouble with currencies and monetary easing

  1. I agree, Douglas was trying to tell us something…

    “And so the system broke down, the Empire collapsed, and a long sullen silence settled over a billion worlds, disturbed only by the pen scratchings of scholars as they labored into the night over smug little treaties on the value of a planned political economy”

    • Hi StrollingDownTheHighway

      Perhaps there was another on QE too.

      “We are now cruising at a level of two to the power of twenty-five thousand to one against and falling, and we will be restoring normality just as soon as we are sure what is normal anyway.”

  2. Hi Shaun
    This seems to be all about LTTRO, the rest is smokescreen. They must be really worried something big is about to go ‘pop’. The lack of screaming from Germany suggests Deutsche?

  3. Flippin’ great; in a few days I’ll be wading through letters offering me balance transfers at 0% for forty years (3% handling fee).

  4. 1157 billion Euros. One thousand, one hundred and fifty seven billion Euros. This will now rise by 2.7 billion Euros a day, rather than the paltry 2 billion a day until now.
    If you take Europe’s population as 500 million, that is:
    1. 5 Euros a day per person of QE;
    2. 150 Euros a month;
    3. 1800 a year.
    Words like unbelievable, unsustainable, come to mind and yet these gigantic sums seem to be of only passing interest the day after any announcement.

    • Good post, I hadn’t thought of it per capita. It might even be higher as the 500M population of the EU includes non Euro countries including the UK.

    • I thought the housing market was out of kilter with average salaries in 2002.

      2007/8 happened and I thought things would balance out.Then TPTB decided the solution to a debt bubble was to blow an even bigger one.

      It’s hard to get your head around the figures and it’s hard not to feel alone when you question the sanity of the CB’s and the Govt.

  5. By the way, off topic and I know that you don’t do politics, but I couldn’t help laugh at the new Labour fiscal responsibility policy. According to the radio, it will not apply during periods of “exceptionally” low interest rates.
    I guess that it may never apply at all, then!

    • Hi James

      Good point as “normal times” gives a get out that extends for a while as after all the LTTROs announced by Draghi go to 2021 as a minimum. I was wondering about “investment” which tends to get perverted. In the interests of balance as I want to stay clear of the politics the bit below is rather similar to what the current Chancellor has promised but not yet delivered. From the New Statesman

      “A Labour chancellor will have to show at every budget, according to Office of Budget Responsibility (OBR) calculations, that s/he can balance the books in five years’ time.”

      so in summary the rules on both sides won’t be adhered too unless they get incredibly lucky on economic growth.

  6. Hi Shaun
    After reading todays blog, twice, I
    have come to a conclusion.

    The answer is 42!

    The Beatles “Nowhere man” Draghi’s song.

    He’s as blind as he can be.
    Just sees what he wants to see.
    Nowhere man can you see me at all?


    • Hi JRH

      It took Deep Thought some 7.5 million years to come up with that. As to the song Rubber Soul is my favourite Beatles album. Packed full of great songs. Although younger readers are probably wondering what’s an album? Their loss I think as at its best the need to fit music onto 2 sides of a sheet of vinyl really inspired some.

  7. Back to Alice in Wonderland –
    “Either the well was very deep, or she fell very slowly, for she had plenty of time as she went down to look about her and wonder what was going to happen next.”

    • Hi Eric

      Well chosen and let me reply with The Hitch Hikers Guide

      “It startled him even more when just after he was awarded the Galactic Institute’s Prize for Extreme Cleverness he got lynched by a rampaging mob of respectable physicists who had finally realized that the one thing they really couldn’t stand was a smartass.”

  8. A pity I didn’t read this on the day, but, despite the knowledge I won’t get an answer I can’t contain myself so here goes:

    Shaun, have you considered the reason markets may bid up currencies that have negative rates attached to them by their CB’s is because markets believe the economy which said currency supports is on the way up or likely to be so in the next few months? This is certainly my explanation for the Euro. The EZ looks good this year for growth, I’m already placed but may try a few positions in Euro denominated bond funds investing in EZ company debt given the ECB’s announcement and as like as not benefit from an appreciating currency (due to improving monetary conditions already in place last Autumn before the ECB started it’s performance) in addition to gaming the ECB bond purchases.

    On the strength of the Swissy with such a negative rate….well…it does have a cracking economy…….

    On Japan I never have understood it so I stay away and try to refrain from comment.

    • Hi Noo2

      The system is not good at flagging up replies to older posts but it caught my eyes this time especially with you saying there wouldn’t be one! Japan is the flaw in the argument an economic recovery is expected with QE which then raises the issue that it has been at the game longest and is currently pusuing it with the most enthusiasm. The phase of QE from the ECB has coincided with a bit better economic growth performance but was that due to the Euro fall which has now ended and maybe eroding? Maybe people are like you front-running expected ECB purchases…

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