Lowering the Euro Curve

Late Wednesday, Standard & Poor’s added the 27-nation European Union to its list of entities on credit watch negative—plus a host of banks and individual municipalities. This rounds out a list that already included 15 eurozone countries and the EFSF, added just two days before. Rather than highlighting a fresh new risk, it appears to us S&P’s just confirming what most folks already know. (For more on S&P’s credit watch negative list, see our 12/07/2011 cover story, “Differentiate Before You Downgrade.”)

That the Eurozone has problems—some more severe than others—is hardly news. In fact, it’s been front-page headline fodder for close to three years now. What’s also not new are the (sometimes agonizingly slow and sometimes disjointed) steps officials continually take to attempt to rectify the region’s fiscal issues with the aim of maintaining the union—at least for the near term. As we’ve written in this space frequently, it’s in no one’s best interest to allow a disorderly breakup of the union.

Case in point, and perhaps the timing wasn’t entirely coincidental, early Thursday morning ECB President Mario Draghi announced a series of measures to increase liquidity in European financial markets—like, lowering the rating requirement for collateral the central bank would accept from commercial banks, among other things. The ECB will now accept “asset-backed securities with at least two ratings of –A as collateral”—which could certainly sidestep or at least blunt some consequences should S&P follow through on any or all of their downgrade threats.

Other measures announced:

• As expected, the ECB lowered its benchmark rate by 25 bps, returning it to an all-time low of 1.0%. Higher than America’s target rate, but very low just the same.
• Two programs to offer unlimited 36-month credit to eurozone banks.
• Reserve requirements for commercial banks were cut from 2% to 1%. This is estimated to add nearly €100 billion in extra liquidity to the system.
• Importantly for smaller banks, residential mortgages and business loans will also be accepted as collateral to borrow from the ECB.

Measures enacted by the ECB Thursday are far from a cure-all to fix the eurozone’s copious issues—but they do represent incremental steps to add liquidity at a time when it’s perceived to be much needed. Some grumped it wasn’t enough, hoping the ECB would increase its direct bond purchases. Draghi indicated anyone expecting a dramatic increase in ECB bond buying at this point had misconstrued his earlier comments. With another European Summit starting Friday, there’s little real reason for the ECB to take radical action that could reduce political leaders’ incentive to act. Europe’s challenges aren’t easily solved with progress coming in fits and starts. But with a common goal of maintaining the eurozone, politicians and the ECB are at least moving in the right direction, even if progress is at times frustratingly slow and uneven.