ECB: Defining “Well Past” on Rates

Published on March 15, 2018
SGH Insight
The Governing Council will discuss the anchoring of rate expectations and the parameters around its commitment to rates at either its June 14 meeting or possibly the July 26 meeting in the run up to the September expiration of the current QE Program.At those same June and July meetings, the ECB will also discuss the parameters of its reinvestment policy for its bond holdings maturing in 2019 and beyond.The reinvestment decision has not yet been made -- but it will have a policy impact -- and it is highly likely from what we understand that maturing bonds will be reinvested in a roughly duration-neutral manner, as opposed to, for example, reinvestments into shorter maturities that would accelerate the pace of the ECB balance sheet wind-down.
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The overarching objective of the European Central Bank over the next eighteen months will be to manage its policy normalization process in a manner that does not jeopardize the Eurozone recovery and the hard-fought progress towards hitting its inflation objective.

To avoid an inadvertent triggering of unwarranted tightening of financial conditions — especially with a whole scale leadership transition in sight — this translates into a high priority for predictability in the ECB Governing Council’s communications on the unwinding of the current 30 billion euro per month net new asset purchase program this year.

It also means predictability on the normalization of interest rates from the current negative 0.4% deposit rate in 2019.

*** From what we understand, “well past” will be defined as a time commitment, and specifically a commitment to keep rates at current levels for six months (or beyond) the end of the current Asset Purchase Program. With the APP effectively now tapering to an end in December, this new commitment on rates policy of “six months or beyond” will translate into a first rates lift-off in June 2019, at the earliest, if all goes as planned. ***

*** The Governing Council will discuss the anchoring of rate expectations and the parameters around its commitment to rates at either its June 14 meeting or possibly the July 26 meeting in the run up to the September expiration of the current QE Program.At those same June and July meetings, the ECB will also discuss the parameters of its reinvestment policy for its bond holdings maturing in 2019 and beyond. ***

*** The reinvestment decision has not yet been made — but it will have a policy impact — and it is highly likely from what we understand that maturing bonds will be reinvested in a roughly duration-neutral manner, as opposed to, for example, reinvestments into shorter maturities that would accelerate the pace of the ECB balance sheet wind-down. ***

Beyond anchoring any remaining debate over lift-off, ECB officials may also have some words to say about the trajectory, and market expectations, for at least those first, few critical steps in the interest rate cycle. Namely, they may stress that those first-rate moves will come in a steady, gradualist, and linear fashion.

What that means in practice is that markets should not expect any unusually steep path at first designed to “normalize” out of negative levels, or conversely, to look for the ECB to pause simply upon crossing the threshold into positive territory.

Lift-off and “Six Months or Beyond”

The key policy concept underpinning the desire for transparency on lift-off in addition to the unwinding of the APP program is the closely intertwined nature of all monetary policy tools – i.e., the ECB cannot change one instrument without affecting the others.

As the ECB gets closer to the end of its bond buying program, the current guidance on rates will be considered insufficient and in need of enhancement to define what a commitment to holding rates at present levels “well past” the end of the bond buying even means?

The well past can be defined by a date or time limit, a link to indicators, or by an altogether qualitative assessment. ECB officials believe a qualitative metric would be far too complicated, and linkage to an indicator could run the risk of inadvertently fostering more, rather than less, policy uncertainty.

And so the well past commitment is highly likely to be defined by a “not too hot, not too cold” explicit time frame. A 12 or certainly 18 month commitment would lock the ECB in far too long, whereas, conversely a three-month commitment would be seen as “rather cheap” in achieving any forward guidance benefits a commitment would be intended to achieve.

From what we understand, a compromise agreement is taking shape within the Council for a commitment to changing the guidance to a period of “six months or beyond” for when a first rates hike will take place once the bond buying program ends.

The Murmurs on Leadership Transition

While not publicly stated, the desire to guide expectations firmly beyond the APP program is being driven, we believe, in part also by an acknowledgment among the ECB leadership that markets will be sensitive to changes in the leadership and make-up of the Board of the central bank that will be coming just as it is embarking on a normalization process after years of ultra-accommodative policies.

On the next, and critical, appointment to replace Chief Economist Peter Praet, Ireland’s Central Bank Governor Philip Lane — who was touted for the Vice President slot that went instead to Spain’s Finance Minister Luis de Guindos — is generally assumed to be the lead candidate.

Lane is, critically, a candidate with a solid economics background, one that will be very much in demand at the new Executive Board. ECB President Mario Draghi, Chief Economist Praet, and Executive Board member Benoit Coeure, who will be the last to leave in December 2019, are all highly trained economists.

From what we understand, the Irish government is likely to put forward an alternative, also highly qualified, female candidate for Praet’s powerful position instead: Sharon Donnery, currently the Deputy Governor at the Central Bank of Ireland. Coming up through the regulatory side for most of her career, Donnery was appointed to the deputy governor position in March 2016, and is currently representing the Irish central bank at the European Systemic Risk Board and chairs the Single Supervisory Mechanism High Level Group on Non-Performing Loans.

As to the Presidency itself, the widely assumed front-runner, Bundesbank President Jens Weidmann, has been notable in his efforts to keep in close lockstep with the current leadership’s policy framework, now slowly beginning to be unwound, after some initial clashes with Draghi and Praet over the QE program.

But questions will most certainly be raised over how Weidmann, given his past objections, might respond again if the Eurozone was to see itself in a renewed downturn or crisis. In a challenge to his potential leadership, some quiet but real energy and lobbying efforts are beginning to be felt around François Villeroy de Galhau, the current Governor of the Banque de France, as one alternative.

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