With concerns rising over the potentially increasing downside risks from China, Brexit, and global trade, markets are sniffing for signs of additional accommodative support from the European Central Bank when the Governing Council convenes again on June 6, in Vilnius, Lithuania.
*** Indications are, however, that the June meeting will not see any significant changes on guidance, and certainly not on interest rates, despite this being one of the Governing Council’s four annual staff macroeconomic forecast revision sessions. Instead, the focus will mostly be on the release of the outlines of the TLTRO III liquidity program for the Eurozone banking sector. ***
The Economic Forecast and Backdrop
At its upcoming meeting in June, ECB President Mario Draghi and the Governing Council will roll out their new, quarterly staff macroeconomic forecast revisions, the ultimate driver to the direction of monetary policy, against the backdrop of some major internal personnel changes at the central bank.
The June forecasts — already revised downwards from December to March — will include some further adjustments to the downside on growth.
But perhaps what may capture the market attention will be a repeated emphasis by Draghi on continued external downside risks to the ECB’s baseline forecasts from the now familiar set of concerns emanating from China and global trade contraction, a possibly increasing risk now of a hard Brexit, and a delayed but still unresolved spat over autos with the US.
But it is not all gloom, and ECB officials have taken heart at some modestly more positive data points that have come out recently after the severe collapse in activity that characterized the turn of the year into early 2019.
While the PMI survey data remain somewhat anemic, we expect Draghi will point to resilience in real data from the service and construction sectors, supported by still strong gains in employment and wages.
Manufacturing, however, remains clearly the Achilles heel of the Eurozone, and of Germany – the sector, not surprisingly, most directly impacted by those ongoing external risks.
And in regards to inflation, ECB officials, like their counterparts at the Federal Reserve, will be looking to sort through how much of the current weakness is structural and how much cyclical, and thus more directly responsive to monetary policy.
A Low-Key Meeting on Policy
As to any changes to policy, the major focus of the ECB will be on rolling out the outlines of the long-awaited TLTRO-III liquidity program for the Eurozone banks.
From what we understand, the objective is to release the outlines of the program now in order to provide some leeway for the full rollout in September.
At the last Governing Council meeting, there was a discussion in principle over whether the objective of the TLTRO-III should be a monetary policy one to turbo charge the economy with an aggressive new infusion of liquidity, or constructed more narrowly to maintain adequate liquidity for banks. The ECB appears to be leaning towards the latter.
As to forward guidance, Draghi already extended at the last meeting the ECB’s commitment to the current -0.4% negative deposit rate “at least through the end of 2019, and in any case for as long as necessary,” so not much room to expand from there.
Markets, of course, have long lapped up that guidance, and are now not expecting a rates lift-off until spring of 2021. While Draghi could well force through some more changes on guidance should he see the need, we understand another change to guidance to be highly unlikely, coming so soon on the heels of an extension of guidance at the last meeting.
More importantly, with half a year remaining in the ECB’s time contingency guidance, there is still plenty of time to make more changes if necessary deeper into 2019.
As to rates, it appears the discussion over the tiering of interest rates to help the banking sector is for all practical purposes dead.
The tiering debate, originally pushed by Banque de France Governor Francois Villeroy de Galhau, was picked up in a mention by Draghi himself earlier this year, to potentially ease the burden on bank profitability or, though left unsaid, allow room to cut rates deeper.
But Draghi’s support appears to have been lackluster at best, and the Governing Council has for now found little justification on monetary policy grounds to help an inefficient and overly banked system in need still of significant consolidation.
Lest it be forgotten, Draghi will also likely point again to the ECB reinvestment program, or more specifically, to the continued massive size of the central bank’s balance sheet as their commitment to continued aggressive accommodation.
And ECB officials, in another mirror of the Fed, will be sure to reference their newly emphasized goal of a symmetric target for inflation, which in the ECB’s case means “the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.” That, at least, is the theory.
Longer-term Euro Shifts
From what we understand, the ECB has also been in the process of reviewing long term strategies, including a discussion of moving away from their neutral stance to date on the internationalization of the Euro, to an official support of that goal.
In addition, the ECB is putting renewed focus on the development of a Eurozone-wide safe asset. While ultimately that would be a political decision that needs to get around the continued concerns (in Germany and among other allies) over the risks of mutualization, the push for a risk-free Eurozone asset has been growing, and the ECB can hold considerable sway in moving that debate forward.
And in a sign of the times, the ECB is also looking at the long-term impact of climate change on the economy, and potentially on policy. That includes, on a more micro level, from what we understand support already for eco-friendly EIB backed bonds.