ECB: Draghi’s Last Push

Published on June 26, 2019

In his final keynote speech at the Sintra, Italy, conference on June 18, European Central Bank President Mario Draghi delighted investors in setting a low bar to further stimulus by indicating a willingness to ease if the upcoming data were simply to not improve, and in using the definitive “will,” instead of “may,” to characterize the ECB’s readiness to move should that low bar be met.

** Draghi’s message was intended not just to open the door – and gather consensus around the Governing Council table — to further easing: it was also designed to definitively refute the market’s more hawkish interpretation of the extension of forward guidance at the June 6 Governing Council meeting for current low rates to remain at present levels “at least through the first half of 2020” as a sign that the ECB was, in fact, not ready to cut deeper than -0.4% on the deposit rate.

** But aggressive as Draghi was, ECB sources indicate that the upcoming July 25 meeting may still be too early for a cut, with the greater likelihood for an ease to come at the next Governing Council meeting on September 12. And a further round of easing, from what we understand, is “not set in stone,” and will still depend on incoming data, as well as on the outcome of this weekend’s Trump-Xi G20 meeting and the course of the trade disputes that have weighed heavily on the Eurozone manufacturing sector. 

** As a holding measure, the Governing Council in July may change its guidance on rates to read that rates, as they indicated before the attempts to normalize policy, could be “at present or lower levels,” instead of the current “at present levels” phraseology, in the policy horizon period ahead. In addition, Draghi will most certainly stress the symmetrical nature of the ECB’s inflation target, a message he has emphasized over the past months, but which has yet to be fully embraced in some of the northern Eurozone countries. 

** As to the levers the ECB may eventually pull, there has been a good deal of press in recent days about revising the 33% Asset Purchase Program limits to open the door to further bond purchases if needed, but the simpler, and more likely initial policy lever will be a deeper cut in the deposit rate, from -0.4% to -0.5%, or even -0.6%.

** Acknowledging that the “effective lower bound” for rates also has its limits, and that a deeper cut may need to be accompanied by tiering, or “mitigating measures,” to cushion the banking system, officials note that the Swedish Riksbank, for example, has held its rates at a spread of -0.75% below its repo rate, with little sign of any adverse side-effects including any excessive hoarding of cash.

** Furthermore, while additional bond purchases have an impact along the yield curve, it has not gone unnoticed that Eurozone bond yields have collapsed already since, ironically, the end of the Asset Purchase Program last December. And while the ECB will never acknowledge this openly – and certainly not to President Trump – the empirical evidence since cutting rates below zero in 2014 indicates that the negative carry in the front end is more directly impactful in weakening the Euro exchange rate than bond purchases, a major factor for the export-driven Eurozone economy.

** As to the all-important inflation data, ECB officials down-play an uptick in April as seasonally driven and acknowledge the drop off since then in the numbers, settling around in the anemic 1.3% area. And like their colleagues at the Fed, ECB officials also point to a discrepancy between market-based and forward measures of inflation expectations, which have plunged, and survey measures that are down, but not quite out, or as the expression goes, “de-anchored.”

** Domestically, on the data front, the ECB will also be paying close attention to wage developments that were off to a strong start in Q1, but that are expected now to taper off in the months ahead, with major union collective negotiations, particularly in Germany, already having been concluded.

Finally, a few quick points on the battle over the succession to Draghi for ECB President: 

** European Council President Donald Tusk has scheduled a dinner of Eurozone leaders for this Sunday, with preparations for the dinner to stretch into breakfast the following day if needed to break the current impasse over the key European Commission and ECB leadership positions. 

** While not a firm deadline – there will be three more occasions for horse trading if needed — that urgency is in part driven by an upcoming European Parliament meeting on Wednesday to select its own leader. In usual EU horse-trading fashion, the nationality of the EP President could preclude some countrymen from taking the more powerful EC and ECB positions.

** And while fluid as always, the indications for now are for a third party compromise, neither French nor German, for both the EC and ECB presidency positions. 

** If German Chancellor Angela Merkel were to come up with a substitute for EPP Party Head Manfred Weber for the EC job – awkward but not impossible — France could still get its candidate in for the ECB. But if there is a smaller third-country compromise, as largely expected, for the EC, French President Emmanuel Macron would block any German candidate for the ECB position.

** Among the third (northern) country candidates, former Bank of Finland and ECB Governor Erkki Liikanen is often mooted, an eminently qualified central banker even if, at 68, he is seen by some as slightly advanced in age for the 8-year ECB Presidency, despite his hobby and fondness for running marathons. Indeed, the edge may lean slightly to his successor, fellow Finn Olli Rehn (57), both a politician and then a central banker. 

** The candidacy of De Nederlansche Bank head and ECB Governor Klaas Knot is complicated by his and the DNB’s traditionally more hawkish lean, as well as Dutch aspirations for other EU positions. The DNB, however, does score well institutionally on issues of diversity and climate change, both important to the ECB.

These battles will kick into high gear on Sunday, and while far too early for solid predictions, including a ruling out of either Bundesbank President Jens Weidmann or the Banque de France’s Francois Villeroy de Galhau, as things stand, the presidency of the ECB appears may be Finland’s to lose.

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