ECB: Pushing for a Full Package

Published on September 5, 2019
SGH Insight
Since Bank of Finland Governor Olli Rehn delighted markets in mid-August in calling for the European Central Bank to overdeliver on expectations with an “impactful and significant” stimulus package at its upcoming rate setting meeting on September 12, no less than five of his fellow Governing Council members have publicly come out against a package next week that would include a resumption in the ECB’s Asset Purchase Program.

*** We believe, despite the frayed consensus within the Governing Council, that a bond buying program in perhaps the 20-30 billion euros per month range was nevertheless included in the options presented on Tuesday to ECB officials for consideration in the run-up to the final stimulus decision next week. ***

*** The first course of action next week, and where there is clearly far greater consensus, remains on the interest rate side, where we believe the proposed options include a cut of 10 or 15 basis points in the ECB’s currently negative 0.4% benchmark deposit rate. While a handful of analysts may expect, or hope for, a larger 20 basis points cuts, we do not understand that to be on the table. ***

That cut will be accompanied as expected with “mitigating measures,” or tiering, to exempt some bank deposits from the deeper punitive rates and soften the blow on the Eurozone banking sector. We suspect that tiering will be limited – after all negative rates are not the core issue ailing Eurozone banks – and could be tied to metrics that would ensure that the banks that do receive relief are in turn doing their part in lending money out into the system.

Market Validation
(Bloomberg 9/12/19)

Treasuries Climb, Following Bund Rally After ECB Policy Decision

Treasury futures hit highest levels of the day as bunds jump following ECB policy decision to restart quantitative easing from November 1, while cutting deposit rate by a further 10bp to -0.5%.
European bonds rally with Italian 10-year yields dropping as much as 12bp while bunds richen ~4bp, outperforming Treasuries by 2.5bp
Treasury 10-year yields drop back to 1.70%, richer by 3.5bp on the day; front-end and belly led gains steepen 2s10s and 5s30s post-ECB announcement

Since Bank of Finland Governor Olli Rehn delighted markets in mid-August in calling for the European Central Bank to overdeliver on expectations with an “impactful and significant” stimulus package at its upcoming rate setting meeting on September 12, no less than five of his fellow Governing Council members have publicly come out against a package next week that would include a resumption in the ECB’s Asset Purchase Program.

*** We believe, despite the frayed consensus within the Governing Council, that a bond buying program in perhaps the 20-30 billion euros per month range was nevertheless included in the options presented on Tuesday to ECB officials for consideration in the run-up to the final stimulus decision next week. ***

*** Our understanding is also that for outgoing ECB President Mario Draghi and many of his colleagues, a desire to address the ongoing weakness in the Eurozone with a forceful package of measures outweighs any of the hawks’ concerns over saving this element of the central bank’s limited ammunition for Draghi’s successor, IMF Managing Director Christine Lagarde, in case of a deeper slowdown. And should the Council still decide to refrain from including bond purchases among its easing measures next week, a real possibility, we expect it will reference a readiness to implement one, if needed, in the future. ***

*** The first course of action next week, and where there is clearly far greater consensus, remains on the interest rate side, where we believe the proposed options include a cut of 10 or 15 basis points in the ECB’s currently negative 0.4% benchmark deposit rate. While a handful of analysts may expect, or hope for, a larger 20 basis points cuts, we do not understand that to be on the table. ***

That cut will be accompanied as expected with “mitigating measures,” or tiering, to exempt some bank deposits from the deeper punitive rates and soften the blow on the Eurozone banking sector. We suspect that tiering will be limited – after all negative rates are not the core issue ailing Eurozone banks – and could be tied to metrics that would ensure that the banks that do receive relief are in turn doing their part in lending money out into the system.

Breathing Space and Ammunition

In contrast to much of the speculation in markets, Draghi’s thinking appears to be that the priority, in his swan song act as President of the ECB, is for the Council to enact a complete and effective enough stimulus package to allow Lagarde some breathing space upon taking the helm of the ECB on November 1, rather than to try and save ammunition for his successor.

Having faced a crisis himself almost immediately upon his assumption of the ECB Presidency in November 2011, we believe Draghi and many of his colleagues will now put a premium on clearing the deck for the incoming Lagarde to focus, initially, on a broader set of issues that includes an assessment of the array of policy tools available to the central bank, and a potential revision of the ECB’s still stated, but already drifting, definition of its inflation target from “below but close to 2%,” to a symmetric target around 2%.

That review, from what we understand, will also include an assessment of the relevance at this point of the ECB’s monetary aggregate “second pillar,” communicated at every Governing Council meeting, but already largely ignored by investors. More broadly, Lagarde will also seek to deepen coordination as needed among the global central banks, leveraging her long-time role as IMF head in Washington, as well as with the still reluctant and highly fragmented fiscal authorities in the Eurozone.

And so while a desire to preserve some of the ECB’s limited ammunition in case of actual deflationary pressures has been cited by many of Draghi’s colleagues in opposing additional bond purchases, an undershoot on stimulus now would raise the risk that Lagarde could be forced instead into immediate fire-fighting mode at the onset of her tenure, a legacy Draghi does not want to leave.

And that means Draghi may have to take some dissents in this, the ECB’s first major monetary policy decision in nearly a year. It will be a close call, either way.

The Case for Restraint

The freezing of any net new bond purchases over the last year has created some headroom for additional bond purchases in the 20-30 billion euros per month range, without any need to raise the central bank’s self-imposed sovereign bond issuer ownership limit of 33.

But that is only for a limited period, and even a potential raising of this 33% limit, while briefly considered, appears to now be off the table, and is not included in the ECB’s immediate policy option.

Especially in light of political changes afoot in Germany, the consensus among ECB officials, including Lagarde, is to avoid any conflict with the European Court of Justice decision upholding the legality of the ECB’s quantitative easing program, as long as the central bank does not own a share of any sovereign issuance large enough to enable it in a worst-case scenario to support or dictate the terms of a potential haircut to its holding.

That, of course, would constitute an illegal monetary financing of governments by the European Central Bank, and it all argues for restraint in pulling the bond buying lever again.

As to broadening purchases beyond the bond markets, the ECB will stress its flexibility in choosing what assets to buy, but a purchase program for equities, including in “blind” market index or ETF forms, has, as we have written in the past, never in any realistic sense been on the table.

While equity purchases are conducted by other central banks such as the Swiss National Bank and Bank of Japan, it is politically dead to the ECB, especially in a Eurozone where equity ownership is still limited in the broader population.

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