ECB: Coordinating Monetary and Fiscal Measures

Published on March 5, 2020

When European Central Bank officials meet next Thursday, March 12 — whether in person or through videoconference – President Christine Lagarde will be facing a Board and Governing Council that is, on the margins, a tad more hawkish than under her predecessor, Mario Draghi.

With the coronavirus crisis already hitting global economic activity, including deep in the heart of European Union founding member Italy, the ECB will take measures on Thursday in an attempt to also signal coordination with monetary authorities around the globe, and in expectation of at least some parallel support on the fiscal side.

*** Announcement of a new TLTRO (“Targeted Longer-term Refinancing Operations”) round next week appears to be all but guaranteed. While more controversial, we would put greater than even odds that consensus will be forged within the Council for a further cut of 10 basis points in the currently -0.5% benchmark deposit rate. ***

*** There appears, on the other hand, to be no push at this time for a step up in the ECB’s bond purchase program. As opposed to the interest rate lever, revival of the Asset Purchase Program already met with great resistance last September when pushed through by then President Mario Draghi, and more to the point, the flatness already of sovereign yields along the curve and across the continent provides little justification for a bigger round of QE. ***

*** On the fiscal side, EU officials note that the Stability and Growth Pact already provides a provision for a temporary break in the 3% Deficit/GDP limit in certain cases of crisis. And on the national level, Berlin appears to be closing in on an agreement to cut corporate taxes, bring the elimination of the “Solidarity Tax” forward to this summer, and allow the Labor Ministry to provide subsidies to help retain jobs or make up for lost hours and wages across hard hit industries. ***

TLTROs, Rate Cuts and Bond Purchases

To backstop liquidity, the ECB is certain to announce a new round of TLTROs next week for the Eurozone banking system. In a call with European Finance Ministers, Lagarde, from what we understand, assured that the ECB would take measures to tackle liquidity constraints, and there appears to be minimal if any resistance to this pre-emptive measure within the Governing Council.

Perhaps more intriguingly, ECB sources also note that in providing help to the banking system, a new round of TLTRO loans would help mitigate the potential negative side effects of a deeper cut in the ECB’s negative, currently -0.5%, benchmark deposit rate, in addition to the ECB’s existing “tiering” mitigation measures.

The Governing Council is still split on the merits, or impact, of another 10-basis points rate cut to -0.6%.

But even as a case will still need to be made between now and Thursday, the imperative to demonstrate solidarity with the Federal Reserve and other central banks who have pledged to take action to cushion downside risks looms large, and with an economy especially vulnerable to a hit in Chinese demand, tourism, and exports, we ascribe better than even odds that the ECB will deliver a 10 basis points interest rate cut next week as well.

There does not, on the other hand, appear to be any pressing sense in the Council of a need at this stage in time for stepping up the just resumed Asset Purchase Program by another notch above the existing 20 billion Euros per month level.

The decision last September to resume APP was already far more controversial within the Council than the decision to cut rates, and furthermore, rates along the European sovereign bond curve are so compressed already that the merits of a greater expansion in the ECB balance sheet are at this time not clear to most ECB officials.

On the other hand, unstated in any formal cost benefit analysis, a drop in short rates would at least have a side benefit in keeping the Euro in check against currencies of other jurisdictions cutting their rates.

Communications and Forecast Revisions

As to forward guidance, the Council will leave the door open to additional measures, if needed, as more information comes in. That would include, either stated or implicit, the possibility in case of an emergency of monetary policy decisions outside of regularly scheduled Governing Council meetings.

Growth projections will be revised downwards at this meeting – a quarterly forecast round – but the revisions will be small. Our understanding is that the cut-off date for submitting projections was last week, with the revisions capturing mainly the effect of the last quarter’s slowdown in the Eurozone economy, and less so the expected impact of the coronavirus crisis.

And ECB officials acknowledge they may have been a bit late in shifting their initial expectations of a likely “V-shape” bounce from the crisis to a now more probable “U-shape” recovery. But they do take some comfort in signs of emerging economic activity in China, even as there is little clarity in how deep or long the damage to the Eurozone economy will be in areas including hospitality, travel, tourism, and in manufacturing supply chains.

As to the inflation forecast, ECB officials note that the immediate impact of the crisis can fall both ways, with oil collapsing, for example, while prices of scarce items go up. It does not appear the inflation projections will be revised in any material way to account for the coronavirus crisis.

Coordination with Brussels and Berlin

Of course, ECB officials, as most other central banks, are keenly aware that in a potential crisis scenario any monetary policy response should ideally be accompanied with targeted fiscal measures.

On that count, France’s Finance Minister Bruno Le Maire has played a key role both internally within EU discussions, and in G7 discussions, in pressing for greater fiscal flexibility from national partners.

Indeed, lost in the flurry of market volatility, the Eurogroup put out yesterday a statement welcoming measures being taken on the health and information sharing side, as well as towards addressing downside economic risks. Noteworthy, but only to the keenest of eyes, was the mention three times in that brief statement of the word “coordination” that was included, from what we understand, at the strong insistence of Le Maire.

In anticipation of some potential fiscal stimulus, some outlets have run with rumors that the EU will be relaxing its Stability and Growth Pact 3% Deficit/GDP rule. But in fact a suspension of that limit is not necessary, as the SGP already provides for leeway in cases of recession, and also in response to “unusual events outside the control of governments.”

On the national front, EU sources now expect that Germany’s coalition partner Christian Democratic Union (CDU) and Social Democratic Party (SPD) will forge an agreement that encompasses the CDU’s push for corporate tax cuts with an SPD agreement to bring forward the elimination of the personal “solidarity tax” from next year to this summer, spearheaded by Chancellor Angela Merkel’s CDU ally, Economy Minister Peter Altmaier, and on the SPD side by Vice-Chancellor, and Finance Minister, Olaf Scholz.

There does not appear to be much movement on a consumer tax break, but in its stead our understanding is there is serious consideration in Berlin of providing subsidies if needed through the Labor Ministry to help retain jobs or make up for lost hours and wages in hard hit industries.

There is a precedent for such subsidies; last enacted in 2009 in the wake of the Global Financial Crisis to help protect workers and to encourage companies to retain employees through that severe downturn.

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