Great Graphic: Another Look at the EMU Transmission Mechanism

This Great Graphic comes from the just released Global Financial Stability Report, with a hat tip Fabrizio Goria, a reporter for Eurointelligence, who posted it on twitter.  

The left hand chart shows the changes the changes in interest rates on new bank loans between December 2010 and January 2013.  It illustrates the divergence between the periphery (upper right corner) and the core (bottom left).  The divergence shows what ECB President Draghi argued was a break down in the transmission mechanism of monetary policy, whereby the central bank's extremely accommodative stance has not filtered through the entire system.

The right hand chart plots real corporate interest rates (by country) against GDP forecasts.  The lower right hand corner is where the core countries are concentrated.  It shows mostly positive growth (Luxembourg and the Netherlands are the main exceptions, though Belgium and France look to stagnate.  The slightest disappointment could push them into a contracting mode. 

Most of the periphery is contracting.  Ireland is the notable exception.  Yet real interest rates remain high.   The ECB seems to be at a loss of what to do to address this divergence.  It does not seem overly impressed with the UK's funding-for-lending scheme.  It could ease the collateral rules for loans to small and medium sized businesses, but it does not seem ready to do so.  

News today that the Bundesbank President Weidmann left open the possibility of a rate cut if conditions changed is being credited with having knocking the euro lower.  It did appear that Euribor futures ticked up as the news broke.  However, it seems like simply a handy excuse to sell the euro, which the short-term market was inclined to do, after it failed to push through resistance seen near the retracement objective of the euro's losses seen since February 1, seen near $1.3230.   

After all, ECB President Draghi had largely signaled the same at his press conference following the council meeting earlier this month.  Indeed that was one of the key take aways from that press conference:  a refi rate cut is possible as early as next month.    

That is worth stressing, what is at stake is the 75 bp repo rate, not the zero deposit rate.   In the current environment it is the deposit rate that acts as a floor for short-term interest rates, not the refi rate.  Although technically, the ECB could cut the deposit rate, the general thrust of official comments is that they are reluctant to do so on the grounds that it may prove more disruptive than helpful.