Showing posts with label ECB rate cut. Show all posts
Showing posts with label ECB rate cut. Show all posts

Sunday, May 11, 2014

11/5/2014: Super Mario: Whatever It Takes Will Now Happen in June… Likely, Like…


This week, the ECB has sent a barrage of signals. Blanket-bombing the Forex markets, Super Mario laid it thick with the promises. Behind this there is less of the classical monetary policy and more of the classical exchange rates expectations balancing. Inflation is low, for sure. Euro is stubbornly stuck in the highs, for sure. The former is just fine for retirement-bound Germany. The latter is not fine for growth centres-bound BMWs and Mercs. So the majority of the Governing Council decided to move… but only in the future… and only once new forecasts are made available.

Basically, Draghi pre-committed to acting in June to ease policy. This is not the same as a promise of QE, neither in the form of actual printing or unconventional measures of any serious significance. Instead, my expectation is the ECB will pass through another refinancing rate cut or do some re-arranging on liquidity support measures side (maturity or volume or both). The Governing Council can then sit back and watch if the marginal move induces downward pressure on the euro. This being June, real economy in Europe will be heading into Summer, buying ECB some time for navel gazing.

Most likely outcome: as long as ECB does not drastically depart from the Fed and BofE, things will remain hard for the euro.

The ECB stance overlays the fundamentals that are consistent with medium-term low inflation and anaemic, albeit improving, growth (see http://trueeconomics.blogspot.ie/2014/05/752014-eurocoin-leading-indicator-april.html). Any easing the monetary policy from here on is therefore consistent with ECB responding to deflationary pressures and Forex pressures, and not to the issues relating to fragmented lending markets. Thus, any easing in June remains conditional on ECB forecasts. Draghi noted as much, stating that

  • Going forward, the ECB is still mindful of low inflation and is concerned with the medium-term trajectory in inflation, so that both levels and dynamics seem to matter now (it was the former and not the latter that were of concern before)
  • The ECB is also worrying about the high valuation of the euro, especially consistent with low inflation. The two factors reinforce each other in the longer run.
  • The fact that geopolitical crisis in Ukraine is now spilling over into the euro area more than to any other region.


The ECB still appears to be undecided on specific tools that it is going to use. Much of this indecision is probably down to the difficulties with structuring some less conventional measures. Much is due to the uncertainty as to how much easing will be required. Intervention for Forex sake will have to be initially smaller than intervention aimed at unlocking fragmented lending markets. This is my expectation for any June action, if any were to take place: symbolic act to alter forward expectations and buy time before end of summer.

The tool kit for this includes potential

  • Shallow cut to refinancing rate: -10 to -15 bps
  • Extending to full allotment of fixed rate liquidity provision. As Bloomberg puts it: "The ECB could extend its policy of granting as much cash as banks need against eligible collateral. The measure was introduced in October 2008 after the collapse of Lehman Brothers Holdings Inc. sparked a global credit crunch and is scheduled to run until at least July 2015."
  • New LTRO. Again, via Bloomberg: "The ECB’s emergency 3-year loans to banks are losing their effectiveness as they approach maturity at the start of 2015, prompting speculation that a new round may be offered. Another LTRO might look different from the previous ones, when banks used most of the liquidity to buy government bonds. “We will want to make sure that this is being used for the economy,” Draghi said in December."
  • Non-sterilisation of SMP (I wrote about this earlier here: http://trueeconomics.blogspot.ie/2014/03/07032014-to-sterilise-or-not-to.html). This can ad up to EUR168 billion to liquidity supply.
  • Reserve requirements can be lower or ECB can remove the reserve ratio of 1%. Both measures will increase liquidity supply.
  • Negative Deposit rate from current zero rate to -0.05 to -0.1 percent (negative rates were used recently in Denmark: http://www.bloomberg.com/news/2014-04-24/danish-central-bank-exits-negative-rates-first-time-since-2012.html). 


I suspect ECB will not go for negative rates, or opt for the outright non-sterilsation of SMP, albeit it can slow down the rate of sterilisation. Negative rates is a nuclear option that will have more significant impact on reducing euro strength. And it might add credit supply in the euro area on the aggregate, though I doubt this will have much of an effect on breaking the vicious cycle of market fragmentation (I find it unlikely that negative rates can trigger restart of credit supply in euro area impaired economies).

In the longer term, I suspect ECB is going to take a wait-and-watch approach through summer. If economic growth continues to pick up and inflation starts to rise, we shall see ECB abandoning any further action beyond the token signalling in June. If things deteriorate over the summer, ECB will look into more QE-focused policies in September-October. Corporate bonds purchases might be on the books then.

Couple of charts to illustrate ECB's long term dilemma:

Policy rates are at historical lows and moving out of synch with Euribor (fragmentation)



Meanwhile, the euribor-ECB spread rose to the highest level since April 2012... The Draghi Put period average spread is at 0.054, pre-Put at 0.594 and current spread is at 0.354. The cost margin in inter-bank markets is now closer to the crisis peak averages than to the Draghi Put average, showing the effects of LTROs and ECB easing wearing out.

And duration and magnitude of deviation from historical averages are frightening:



All of which shows that ECB will have to seriously push the bounds on unconventional measures, if it really wants to make a dent in the pile of problems (forex rates, fragmentation, aggregate liquidity supply, inflation, growth...) the ECB is facing.

Friday, April 26, 2013

26/4/2013: Meanwhile, Patients Still Run the Euro Policy Asylum...


Headlines (via Eurointelligence.com):

  • Angela Merkel: "The European Central Bank would really have to increase the interest rates for Germany";
  • Angela Merkel also said that for other countries, the ECB would have to provide more liquidity for companies;
  • German economics minister Phillip Rosler issued a statement to confirm that the ECB was still an independent central bank;
  • ECB officials, meanwhile, played down expectations that a rate cut would have much of an effect;
  • Joerg Asmussen did not rule out an interest rate cut, but was playing down expectations. He said lower interest rates could work in ways not intended by the ECB, and added that they had virtually no effect in the periphery due to the broken transmission mechanisms;
  • Benoit Coeure as saying that the ECB had done what it can. It was now up to all the European institutions to find ways to solve the problem;
  • Wolfgang Schauble said Italy’s problems were a lack of reforms, and that it would be wrong to blame others for their own misfortune. "... in the eurozone everybody had to solve their own problems. And that is is what Italy needed to do as well. There was no point in asking Germany to take on more debt. Everybody had to run their government in a responsible way";
  • Schauble also said that it would be wrong for member states to depart from austerity path, saying the eurozone problems had nothing to do with strict budget rules, and that "somebody should tell Barroso that".

Conclusion: rest assured - the screw up known as "Euro area policy" will go on unabated no matter what JMBarosso & Co are saying.

ECB rate cut might come or it might not, but it will be minor (25bps) and one-off (with rates unchanged throughout the rest of the year) and it will do no difference whatsoever, other than fuel anti-inflationary rhetoric in pre-election Germany.

Fiscal policy will remain largely unchanged with some states (France, Italy, even Spain?) adopting an Irish-government approach to 'stimulus': find one-off non-tax, like pensions funds expropriation, to fund 'jobs creation programme', while leaving net fiscal adjustments intact. Which will, of course, amount to short-term reallocation of productive funds to unproductive GDP supports, with medium-term negative impact of tax increases and reduced confidence in economic institutions.