The year’s first Monetary Policy Meeting of the European Central Bank next Thursday will be conducted under the cloud of a sharper than expected deceleration in Eurozone growth over the last few months of last year, complicating the ECB’s already supremely cautious 2019 exit strategy from its non-standard stimulative measures.
*** Any formal revisions to the ECB forecast will have to wait until the March 7 meeting, and there is no need or desire in the Governing Council yet to tinker with its existing language around rates lift-off. But President Mario Draghi will acknowledge the slowdown, point to continued stimulative policy measures at the central bank’s disposal, including the roughly 15 billion Euros per month still of bond reinvestments expected for 2019, and emphasize the conditional nature of the ECB policy path forward in case forecasts do materially change. ***
*** In addition, there will be a discussion at this meeting about a renewal of the TLTRO program to provide additional cheap funding to the banking sector. We do not expect a formal decision or announcement next week, but the contingency plan all along for the Governing Council has been to revisit the program by March if necessary – and that is increasingly looking to be the case. ***
*** As to guiding expectations for a rates lift-off, while a few ECB officials want to try and anchor drifting market expectations back in to 2019, more broadly speaking, with downside risks rising, it does not appear that the ECB leadership has any real issue with markets having pushed lift-off and the first interest rate hike, for now, out into the beginning of 2020. And as such, we expect Draghi to emphasize that lift-off is minimally date-contingent (“at least through the summer of 2019”), but more importantly, conditional on the economy and the ECB’s inflation forecasts. ***
Furthermore, ECB sources confirm they, at least, agree with market expectations that the first hike, when it comes, is likely to be an adjustment only in the currently -0.4% deposit rate while leaving the other benchmark rates unchanged, hiking probably by as little as 10 basis points, but in either case no more than 15 basis points that would set the deposit rate at the traditional 25 basis point lower band under the 0.0% Refi rate.
Those “modalities” for lift-off, of course, are still miles away from implementation, and as such will not be the topic of any announcement at this or any meeting soon.
Bond Purchases and Outlook
With perhaps the shadow of December’s Federal Reserve balance sheet market tantrum as a cautionary backdrop, we understand Draghi will remind markets that while the ECB ended its purchase of net additional new bonds, as expected, last December, reinvestments of maturing bonds by and large – at least this year – will be running at around a whopping 15 billion euros a month.
That, pointedly, was more or less what they had been buying in the last three months of last year.
In the meantime, Draghi has previewed the message on the broader assessment of recently deteriorating economic conditions that will be sure to follow the meeting of the Governing Council.
On January 24, in the closing remarks following a speech before the European Parliament in Strasbourg, Draghi said while he does not see a recession, he frankly conceded he is bracing for a slowdown that will indeed be longer than originally expected. Unsaid is that the slowdown has also come sooner, and been deeper, than expected by the ECB.
And so the ECB will not be sitting on its hands until lift-off, as may have been the case in a more benign normalization scenario.
TLTRO and Banks
From what we understand, the ECB will almost certainly open discussions at this meeting on a potential new TLTRO program for European banks, a discussion which was postponed from last year for having been premature at the time (see SGH 11/19/18, “ECB: The December Governing Council Meeting”).
And while we expect no decision on TLTRO will be made on Thursday, we would expect the ECB to have every incentive now, as opposed to in 2018, to communicate that such additional liquidity measures are likely to be forthcoming. Timing wise, the current TLTRO programs do not roll off until 2020, but a case will be made that banks need some (positive) funding visibility about a year in advance.
The communication over a new TLTRO program will hew closely to monetary policy and its benefits to the transmission of stimulus to the economy as a whole, and not as a sectoral lifeline to a banking system that in fact is not particularly short on liquidity, and especially not as a response to any specific country or bank.
Italy – More of the Same
To that, ECB officials shrug at the recent travails of Italy’s Banca Carige, downplaying them as essentially more of the same, and pointing to the small size of that bank as opposed to the problems last year with Monte di Paschi, which was the number three bank in asset size in Italy at the time.
And so there is not even the smallest whiff of systemic risk nor an acute need in the banking sector for ultra-cheap funds – a decision to introduce a new TLTRO program all comes down again to the need for additional macroeconomic stimulus and a desire to lubricate the transmission mechanism of still accommodative policy from the banking sector into the real economy; in other words, a bit more reflation.
Indeed, Carige’s diminutive size may even work against any plans Rome may have, despite assurances otherwise, to use public money as a backstop to recapitalize that bank. But that is a micro issue for the European Commission and the ECB’s SSM (Single Supervisory Mechanism) regulatory arm, and not for the Governing Council to worry about.
They have their hands full with the macroeconomic risks.
Low Growth and Germany’s Slush Fund
In their assessment of the balance of risks, it is not lost on ECB officials that minor exogenous shocks — such as low water levels on the Rhine or a massive snowfall in Austria – that could more easily have been absorbed at the, say, 0.4-0.5% quarterly growth rates of 2017 are now having an outsize impact in a potentially 0.1-0.2% quarterly growth rate environment of 2019.
And so the Eurozone may even be one or two shocks away from experiencing a quarter of no growth this year…and that would be bad.
Already, the “yellow vest” protests in Paris and across the country are seen to have had a dampening effect on consumption and tourism over the holiday period in France. But looking ahead, the expectation, or at least hope, is that these riots will slowly play their course, and polls indeed suggest that after a brutal year, France’s President Emmanuel Macron’s popularity rating may even have finally bottomed.
And in Germany, ECB officials are pleased to note (in private at least) that the fiscal debate between the CDU and SPD coalition partners have all been about tax cuts and additional stimulus, and not about further budgetary savings, even as the German Debt to GDP ratio, at a tantalizing 60.2%, approaches the Stability and Growth Pact target of 60%.
But perhaps most to the point, with growth flagging, Berlin from what we understand has already taken pre-emptive steps, quietly stashing an extra 11 billion Euros in the budget under what ostensibly appears to be some sort of “refugee fund,” but which could be drawn on for a rainy day.