The Wilder View

Evidence of Hampered Monetary Policy Transmission Channel in the Euro Area

Mario Draghi cautioned on the ‘hampered’ transmission channel of monetary policy in his now famous London speech last week:

To the extent that the size of these sovereign premia hampers the functioning of the monetary policy transmission channel, they come within our mandate.

I referred to the clogging of rates policy back in April via evidence from mortgage lending rates.

I address Draghi’s point that the ECB 1% refi rate will support economic activity through the lens of the mortgage market. Specifically, I find that the interest rate channel is clogged in the economies that are in most desperate need of lower rates: Spain, Portugal, and Italy.

Here I show that on a relative basis, while the household lending rate is quietly trending down for key periphery markets, the real problem lies in the non-financial corporate rates transmission channel. Specifically, rates in Portugal, Italy, and Spain have seriously diverged from both the trend in the refi rate (ECB policy rate) and those of other countries in the Euro area.

The trend in key periphery household mortgage rates is consistent with the ECB rate cuts: down

Note: All ECB refi rate data is through June 2012, so the latest rate cut to 75 bps is not included in the charts.

The magnitude still favors the core – the drop in German mortgage rates is 91 basis points since the max mortgage rate of the Euro area as a whole in August 2011 – but the trend is down for all countries.

In stark contrast to the trend in household mortgages relative to the ECB refi rate, non-financial corporate lending rates in Portugal, Spain, and Italy diverged from the other country trends.

If the ECB means business on improving the monetary transmission channel, they’ll need to attack the price of corporate loans in the Periphery markets.

Rebecca Wilder

Data Note: All non-financial corporate AAR lending rates is the annualized agreed rate on new business loans with a maturity of greater than 5 years and amount between €0.25 bn and €1 bn. Irish data is not available in Ireland and the Greek data is too sporadic.

2 Responses to “Evidence of Hampered Monetary Policy Transmission Channel in the Euro Area”

Patrick_VBAugust 2nd, 2012 at 12:35 pm

Hi Rebecca,
Thanks for tracking all of these data and for your insights.
I would like to add a thought after reading your post. Even if the ECB is committed to restoring the normal functionning of the monetary policy transmission channel, I 'm not sure that there is much they can do without committing to substantive, massive, policy changes and their political/institutional implications, like signalling the readiness to buy huge amounts of troubled (mainly constructon related) assets with only minimal haircuts, as well as buying amounts of public sector debt (in the secondary market) that more or less stabilise public sector debt stock ratios and/or bring market risk premia on government borrowing rates down to around nil. In other words, the ECB would have to be willing to buy a large share of the euro area's troubled assets and to take the losses onto its balance sheet. Personally, I don't think we're there yet, as the ECB would thus be giving a free pass to the institutions that created the mess through inept governance, eliminate the pressure for reform, set a precedent and lay the foundation for massive future moral hasard.

Douglas UngreddaOctober 9th, 2012 at 5:18 pm

Rebeca thanks for your insights. More than a comment I would ask you if you could comment on the causes behind Italy´s departure from the core .
does it have to do with the aftershocks of the institutions who flunked stress tests forcing higher capitalization ratios and higher lending base rates?
Has the italian recession bottomed out yet despite the ECB´s signals?
Is the italian monetary market insulated as capital controls are still inplace?
A combination of the above ?

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