ECB: Preparing for the Next Move

Published on April 10, 2019

We wish first to congratulate Executive Board Member Peter Praet at this, his last Governing Council meeting, for his remarkable tenure as the Chief Economist of the European Central Bank.

In complete lockstep always with President Mario Draghi, Peter helped drive the intellectual arguments and boldly lead the bank in trying times into previously unimagined nonconventional policies, and when the time was ripe into the process of gradual normalization of the ECB’s monetary policy instruments. His contributions to the ECB and to Eurozone economic policy will be sorely missed.

Now a few brief points about today’s Governing Council meeting:

**Today’s meeting was essentially a placeholder to get through some of the latest Brexit deliberations, and more importantly to assess the Eurozone and global economic conditions to determine among other things if, and when, a tiering of the negative deposit rate will be necessary. More on that below:

**Back in February (see SGH 2/11/19, “ECB: Taking Stock of Ammunition”) we flagged that the ECB would be considering the option of tiering the currently -0.4% deposit rate to ease some of the adverse effects of that “tax” on the Eurozone banking system, and those deliberations were confirmed in March by Draghi, Praet, and fellow Board Member Yves Mersch. Nevertheless, our understanding was that the timing – or consensus — was not quite ripe yet, and that tiering would not be discussed at any great length at today’s Governing Council meeting.

**What we did understand was that a tiering system would be rolled out, in due time, in conjunction either with a full “bank package” that includes details on the new TLTRO3 liquidity measures, or perhaps, albeit less likely, later in the year if the ECB felt the need to extend its forward guidance locking negative rates even further out than the current “at least through the end of 2019” (see SGH 4/2/19, “ECB/Germany: Contingency Planning”).

**Today, Draghi indicated that the linkage of the decision to implement a tiered negative deposit rate system would indeed be to the TLTRO3 rollout, as the ECB assesses the macro-economic necessity to lubricate the transmission mechanism of monetary policy from the banking system into the economy and takes the measure of economic conditions in general.

**That puts almost certain odds, we believe, a tiered system will be instituted before September, when the new TLTRO3 program tranche is due to be rolled out. Narrowing an exact date beyond that is a bit trickier, but we would note there are just two Governing Council meetings between now and then, one on June 6, and the other on July 25.

**While handicapping between June and July is a bit early at this point, we did not fail to notice that Draghi numerous times alluded to the significance of the June meeting to their assessment of economic conditions, that being a forecast revision meeting. So for now, we lean towards June.

**Finally, in our last report we mentioned some “break the glass policy options” the ECB might consider in case the Eurozone economy turned further south or did not stabilize and recover into the second half as expected. In that we included the notion, albeit certainly not a base case scenario, that a tiered deposit rate system would open the door to a potentially even deeper cut into negative territory if needed.

**Draghi was asked this exact question by one reporter – would tiering open the door to potential future rate cuts and should just been seen as a tool to alleviate pressure on banks if (when) the current -0.4% negative deposit rate is extended further into 2020 than the current ECB guidance?

**Not surprisingly, given that it is not their base case, has not been discussed yet, and the ECB does not want to stoke such speculation, Draghi completely punted on the question of further cuts if needed. There was, however, no denial either.

**Finally (this time for real), we also did note with interest that Draghi casually dropped in numerous comments that the ECB mandate clearly tolerated deviations on both sides of their “below but close to 2% over the medium-term” inflation target. These, we believe, are clearly made in an effort, as the Federal Reserve has been now for a while, to push inflation expectations higher to lift inflation above its symmetrical 2% target.

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